Overhaul at SIA Engineering

Over the past decade, the company has expanded outside of Singapore, even as it maintains the lion’s share of maintenance work at Changi. While the SIA group is still a major customer accounting for a big part of its revenue, SIAEC has since established operations in seven other countries, providing line maintenance and heavy checks for various airlines at 37 airports.

Lately, however, the company has been facing stronger headwinds. New-generation aircraft rolling off factory lines in recent years have affected work volumes at MRO service providers, as the newer planes have longer maintenance intervals than the aircraft they are replacing. Many airlines, pressured to bring down costs to improve margins, have tended to defer non-essential MRO work, further driving demand down. In addition, SIAEC faces keen competition from lower-cost countries in the region that are keen on developing MRO hubs to capitalise on fast-growing air travel dynamics.

Meanwhile, some observers have also questioned whether SIAEC’s parentage is now more of a hindrance to its expansion, particularly in securing non-SIA customers. The stock’s low free float, of 22%, is also a concern. Last October, the stock suddenly fell 5% over the course of a morning’s trading, to a six-year low. Despite subsequent analysis pointing out that the decline was triggered by a substantial block trade from an institutional investor, rather than something being fundamentally wrong with the company, the stock has yet to recover completely from that event. At current levels, it is still 24% off its peak last June.

The way Png sees it, the company benefits from the SIA branding — it serves as an assurance of quality to its third-party customers. Still, he is prepared to overhaul the entire company to make it a more effective player. “It’s about what we have to do and not about what has worked for us in the past years,” Png says. “The world has changed so much. Deciding what to do based on the past is no longer going to work. When I was asked to take over, I had a different approach: Basically, to look 10 years ahead, work backwards and decide what we must do right now for us to be prepared [for] the future.”

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Lower revenue, rising costs

Png eschews the limelight and is rather soft-spoken, and one would struggle to hear him above the din of engines and machinery in the hangars. A veteran of the SIA group, having joined in 1975, he rotated through the airline’s operations, aircraft and component services, and services business units.

In April 2015, when he took over the running of the aircraft and engine MRO business, he had his work cut out for him. New-gene­ration models are more reliable, whereas new technology would require MRO companies such as SIAEC to update their services in tandem. “The way aircraft are designed these days, the manufacturer does it to cater to the airlines’ need for lower maintenance costs. That means a reduction in our revenue,” Png explains.

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SIAEC’s earnings performance in recent years bears out the challenges it faces. For FY2015 ended March 31, turnover was down nearly 5% y-o-y to $1.12 billion. Earnings were down 31% at $183.3 million. The following year, it recorded $176.6 million in earnings, on the back of $1.11 billion in turnover.

For FY2017, turnover was still lower, at $1.1 billion. Earnings rose 88% y-o-y to $332.4 million, however, even though operating profit for the year had fallen 31% y-o-y to $72 million. The improvement was due to the $178 million gain from divestments. The company had sold its 10% stake in Hong Kong Aero Engine Services for $141.6 million and also received a special dividend of $36.4 million after HAESL divested its 20% stake in Singapore Aero Engine Services. Without these one-off gains, SIAEC’s net profit for the year would have been 2.6% lower y-o-y at $172 million.

For 1HFY2018, turnover was up 2.1% y-o-y at $547.5 million. Core operating profit at $37.6 million was nearly 15% lower than the year before. Excluding the impact from the divestment gains the year before, earnings came in 1.1% higher at $74.3 million.

Aircraft MRO is notoriously labour-intensive and costs have been rising. Staff costs for SIAEC’s 2QFY2018 ended September rose 5.3% y-o-y to $123.3 million, the largest expenditure component. Corrine Png, analyst at Crucial Perspective, notes in a recent report: “Every 1% rise in staff cost cuts SIA Engineering’s FY2018 net profit by 2%, all other things being equal.”

To be sure, the company has embarked on internal improvements to lower costs and raise productivity. “We adjust and fine-tune processes and so on. But that can no longer give us the improvements we need,” SIAEC’s Png says. There is a need to invest, he explains, for the company to keep ahead in the industry and return to growth.

The long game

In February 2016, the company announced it was setting aside up to $50 million “over the next few years”, with the support of the Economic Development Board, for innovation and technology initiatives. In a statement at the time, Png said SIAEC would identify “and gain competencies in emerging technologies that will be an integral part of the MRO industry in the next 10 years”.

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He added that the company would collaborate with airlines, research institutions and technology partners to develop solutions for airline customers. Key areas to be explored include additive manufacturing, also known as 3D printing; robotics; data analytics; and the digitalisation of systems. “These investments are aimed at developing innovative solutions to enhance airline customers’ fleet operating efficiencies and reliability while creating higher levels of productivity and process improvements in our business,” Png said.

Since then, he has set up the “Innovation and Technology” group, drawing employees from various business functions throughout the organisation — from product development engineers to sales representatives — who devise better ways of working. A 3D printer is used to produce replacement parts for aircraft interiors, such as the cover at the end of a seat’s armrest, or a decorative drainage trap for restroom basins. Also, 3D laser scanners have been brought in to log the damage on an aircraft due for repairs, which significantly cuts down the time it takes traditional visual inspections to do the same.

Further ahead, SIAEC is looking into deploying robotics and autonomous ground vehicles in its hangars, as well as augmented and virtual reality technologies into its work processes. To be sure, AR and VR are not entirely new in the industry. Boeing, for one, has its aircraft assembly workers using AR wearables. Still, it might take SIAEC longer to implement such programmes. VR is being adapted for training in certain areas, but its full deployment in operations depends on manufacturers and aviation authorities’ approval, which is bound to take time.

“Our business is highly regulated, so whatever we do on an aircraft has to be according to the strict stipulations of manufacturers and aviation authorities,” Png explains. Still, it does not mean engineers at SIAEC cannot get started on new methods or equipment. “The same technology can be used on different things. So, we can start with the [non-critical components] and build on it,” he adds.

Nevertheless, several other initiatives have been put into motion. For instance, the company is close to completing the digitalisation of production planning systems, which Png says would be another boost for productivity. The move shrinks volumes of manuals and job instructions onto mobile tablets for engineers, who can access the information anywhere in the airport.

The company is also analysing the tranches of maintenance data it collects for ways to improve its services. In addition, data on aircraft movements, for instance, could be used to improve the company’s own operations, such as optimising the deployment of manpower.

While robotic arms may not be in the immediate future for SIAEC, Png does have a vision for a hangar of the future based on the company’s existing infrastructure and capabilities. “You don’t want unmanned vehicles flying around an airport, so you can mount multiple cameras on the structure of the hangars instead,” he muses. Aircraft inspections can certainly be done by machines, as in the case of the company’s 3D scanners, but repairs can also be done by machines.

Whatever the case, while there may not be a single large-scale, high-tech, high-profile project that will propel SIAEC onto investors’ radars, there are several smaller projects that are ongoing and that will yield cumulative benefits in the longer term.

Indeed, Png is keen that as many initiatives as possible are implemented. “There are a number of things, except that you don’t really see it in the workplace yet,” he says. “We don’t have to analyse it and be so sure that it will work for us. We should just bring it in and try it out, and we must be prepared to accept certain failures [during the process]. Otherwise, nobody would want to try.

“Whatever we can do, we do so immediately. I think, these days, they are calling it the agile approach.”

Ultimately, as an MRO services provider, SIAEC’s objective is to help an airline customer keep its aircraft flying for as long, and as reliably, as possible. Png says: “If we get it right, it’s adding value to customers, which would then help us secure contracts.”

Expanding joint ventures

For now, a major part of SIAEC’s revenue still comes from work done in Singapore. In its FY2017 annual report, it notes that revenues from one major customer amounted to $476.9 million, or 43% of total turnover for the year.

Still, what is notable is that the company’s share of profits from associated and joint-venture companies has been expanding steadily, from $94.2 million in FY2016 to $96.5 million in FY2017. In 1HFY2018 ended September, this grew 16% to $44 million.

“Working with OEMs [original equipment manufacturers], in strategic partnerships and joint ventures, is a strategy we set some years back and it’s worked out quite well,” Png says. “The idea is that, together with [an OEM], we can grow that business better than what we could on our own.

“The OEM has certain competencies and a worldwide marketing network, and access to data and info that we might not have on our own.”

Among the 26 joint ventures and partnerships are the Boeing Asia Pacific Aviation Services venture, which covers fleet management, and Heavy Maintenance Singapore Services, a 65% partnership with Airbus that provides airframe maintenance, cabin upgrade and modification services for the A380, A350 and A330 widebody aircraft. Last October, SIAEC incorporated a joint-venture company with Moog to provide MRO services for Moog-manufactured flight control systems fitted on new-generation aircraft, including the A350 and Boeing 787.

These developments bode well for the company in the longer term, analysts say, noting that SIAEC is using its strong balance sheet, as it is in a net cash position, to start new ventures. “These will significantly enhance SIA Engineering’s capabilities and competitive advantage, providing new earnings growth drivers in the longer term,” notes analyst Corrine.

In addition, the continued growth in air travel in the region as well as Changi Airport’s expansion as an air hub will sustain demand for line maintenance, or more frequent aircraft checks. Commercial aircraft movements at Changi, for instance, grew 4.1% between 2015 and 2016. SIAEC handled line maintenance work for 141,454 flights in FY2017, about 3,600 more than in the previous year.

“It’s almost like a volume business,” Png says. “For each piece of work we do, the value might be lower, but we just need to do a lot more of such work. While the content per aircraft may be lighter, there’s an increase in the aircraft fleet size worldwide, especially in Asia-Pacific. So, we need to be able to do the job quicker, in a shorter frame of time, and do more.

“If we improve on the turnaround time for each check, then we can basically generate additional capacity out of our existing resources. Then we can sell that capacity and go out to secure more work.”

The market remains circumspect about SIAEC’s stock, and analysts who track the company are estimating earnings for the next couple of years to be weighed down by higher expenditure. Phillip Capital has a “neutral” call on the stock, with a price target of $3.35, or a forward price-to-earnings ratio of 24.6 times. The brokerage forecasts earnings of $153 million for FY2018 and $157 million for FY2019.

Crucial Perspective’s Corrine is more bullish, highlighting that SIAEC is likely to be able to sustain a dividend yield of 4% a year, given its net cash and free cash flow positions. She expects the company to post earnings of $156 million for FY2018 and $203 million by FY2020. Png values SIAEC’s stock at $4.50 based on a discounted cash flow, assuming long-term free cash flow of $226 million and a weighted average cost of capital of 5%.