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SIA Engineering braces for full Covid-19 impact; reviews JVs and mulls M&A opportunities

Jeffrey Tan
Jeffrey Tan5/15/2020 07:00 AM GMT+08  • 9 min read
SIA Engineering braces for full Covid-19 impact; reviews JVs and mulls M&A opportunities
SIA Engineering’s 4Q and FY2020 results ended March 31 may have suffered minimal impact from the novel coronavirus (Covid-19) pandemic. But, the worst has yet to come for the provider of maintenance, repair and overhaul (MRO) servi
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SINGAPORE (May 15): SIA Engineering’s 4Q and FY2020 results ended March 31 may have suffered minimal impact from the novel coronavirus (Covid-19) pandemic. But, the worst has yet to come for the provider of maintenance, repair and overhaul (MRO) services to more than 80 international carriers and aerospace equipment manufacturers.

During the quarter, SIA Engineering reported y-o-y earnings growth of 5.9% to $52.2 million from $49.3 million. This brought full-year earnings up 20.4% y-o-y to $193.8 million from $160.9 million. The strong bottom line was driven by an improved operating profit due to its transformation effort, the company says. This was enhanced by higher contributions from its engine and component segment, airframe and line maintenance segment, and associated and joint venture (JV) companies.

However, revenue tumbled 10.4% y-o-y to $229.3 million in the fourth quarter, from $256 million a year ago. This led full-year revenue to fall 2.6% y-o-y to $994.1 million from $1.02 billion. Much of the revenue decline was the result of lower MRO activity.

According to Ng Chin Hwee, CEO of SIA Engineering, MRO services are usually tied to the number of flights. The higher the number of flights, the more servicing is required to maintain, repair and overhaul aircraft. Likewise, the lower the number of flights, the lesser such services are required.

However, as airlines around the world ground their fleet in response to border controls, the number of flights has fallen “dramatically” since February and March, Ng notes. For one, Singapore Airlines (SIA), its biggest customer and parent company, has cut capacity to just 4% of what it used to operate before the crisis.

The national flag carrier and its subsidiary airlines are now carrying passengers on just 10 out of 200 aircraft. Most of the aircraft are grounded at Changi Airport, while 17 planes are parked at the Asia Pacific Aircraft Storage facility in Alice Springs. Some of its aircraft have been repurposed as cargo planes.

See also: SIA and Scoot passenger count up 6.2% m-o-m in October, capacity at 71% of pre-Covid-19 levels

SIA Engineering’s other airline customers have also slashed capacity. Malindo Air suspended all its international operations from March 18 to 31, while Vietnam Airlines has suspended international flights within its network until April 30. Both airlines have yet to announce a resumption of their international operations.

According to Ng, with more old aircraft being grounded, demand for maintenance will be reduced as newer aircraft do not need heavy maintenance. JV and associate companies will also be affected by aircraft grounding as business is generally tied to flight hours and repair cycles. He also expects airlines to trim costs by asking for discounts, though there have been no formal discussions yet as most of the airlines are still adopting a wait-and-see stance.

Meanwhile, several airlines have gone bust. Notably, UK’s Flybe and Australia’s second largest airline Virgin Australia Holdings were among the early casualties. More recently, Avianca — the second-largest airline in Latin America and listed in the US — filed for bankruptcy.

See also: SIA chalks up 1H records, but tempers yield expectations

As such, Ng believes the crisis this time round is worse than the SARS epidemic in 2003 and the global financial crisis in 2008. He warns that the pace of recovery in MRO activity is uncertain.

Turbulence ahead

When a recovery takes place eventually, chances are it will be a gradual one and not a sharp rebound. The International Air Transport Association (IATA) has guided for a U-shaped recovery, instead of a V-shaped one. Such a recovery will be underpinned by the quicker resumption of domestic air travel compared to the international market, says IATA. A case in point is China, which has opened domestic air travel, Ng points out.

However, Singapore does not have a domestic market and is entirely reliant on international flights. “[So] we have really not felt the full impact of Covid-19 [yet],” he said at a May 11 briefing.

Given the situation, Ng says SIA Engineering is “preparing for the worst and praying for the best”. Even when the frequency of air travel to and fro Singapore resumes, safe distancing measures will likely continue to be implemented, he says. This may reduce the number of seats available onboard a plane.

While the load factor is not usually a key consideration for SIA Engineering, it is an important metric to track closely. Airlines may reduce flight frequencies if a route is not profitable. “[Airlines] are dependent on load factors, but we are dependent on flight frequencies. But obviously for airlines, they will not mount more flights unless it is profitable for them,” Ng explains.

SIA Engineering’s MRO business mix may also see a change. Given that domestic air travel is likely to recover faster than international air travel, narrow body planes would be “first off the block for recovery”, says Ng. Regional air travel also usually employs narrow body planes. “After that, hopefully [when] confidence returns, wide body [planes] can have their day in the sky,” he adds.

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Still, for the longer term, Ng is worried about the shape and direction that the aviation industry may take after the Covid-19 pandemic. “If the old planes are not going to fly, then clearly you are going to have a much smaller fleet,” he says. “Cost conservation is one of [the airlines’] considerations.”

As such, Ng says SIA Engineering will be reviewing its portfolio of JV and associate companies. The company currently has 26 JV companies across eight countries. Most of them were established with notable partners, such as Pratt & Whitney, Rolls-Royce Holdings, General Electric, Jamco Corp and Safran.

Ng explains that this exercise will examine each JV and associate company’s business plan, and their relevance to the industry. This may suggest that the company could embark on some divestments. But Ng is mum on the subject. “I’m not in the position right now to tell you or single out any JVs or partnerships that has changed,” he says.

On the flipside, Ng says SIA Engineering may also take the opportunity to embark on new investments, given its strong balance sheet. As at March 31, the company has a net cash position of $506 million.

“We are of the view that the crisis may throw up new opportunities for us that may strengthen our current portfolio of partnerships, as well as bring new capabilities to SIA Engineering. So, we will be looking out in the market for such opportunities,” he says. “[But] we are not going to go out there and pick up distressed assets just because they are cheap. It [must] fit in our portfolio and what is relevant going forward in the market.”

Belt-tightening measures

In the meantime, having SIA as its biggest customer is a silver lining for SIA Engineering. According to the company’s senior vice president of line maintenance & cabin services, Foo Kean Shuh, the national flag carrier continues to be concerned about the maintenance of its planes, though they are grounded. “So, we are keeping our staff busy with aircraft preservation programmes and cabin cleaning programmes while the planes are on the ground,” he says.

SIA Engineering is also in talks with customers to bring forward their schedule for base maintenance checks, says Foo. This type of maintenance requires the removal of an aircraft from service for a longer period, usually more than one day and possibly up to 30 days. Airlines are taking advantage of the lull period to conduct base maintenance so that the aircraft are ready to fly when business picks up, he adds.

Other measures are helping to keep SIA Engineering afloat. For one, the company has and will be able to receive financial support from the government. During the quarter, the company recognised $25.6 million grants under the 25% job support scheme (JSS). Unfortunately, the company did not qualify for the first tier of the 75% JSS because it is not classified under the aviation/ground handler group. But for the “circuit breaker” period of April and May, CGS-CIMB Research says SIA Engineering will qualify for the 75% JSS, along with the rest of Singapore companies.

SIA Engineering has also tightened its belt by implementing cost-cutting measures. Starting from April 1, senior and mid-management have received pay cuts, of which some have subsequently been increased and brought forward from their previous implementation dates. In addition, a voluntary no-pay leave scheme has been offered to all staff. The company’s board has also volunteered a deeper reduction of 25% in fees accruing starting April 1 in solidarity with management and staff.

Based on the May 13 closing price of $1.71, shares of SIA Engineering are down 39.4%yearto-date. At this level, the stock is trading at 9.9 times earnings and 1.2 times book value. The stock has a 12-month trailing dividend yield of 6.4%.

Analysts have turned bearish on SIA Engineering. UOB KayHian has downgraded the stock to “sell” and slashed its target price to $1.57 from $3.13 previously. The brokerage expects the company to report a loss of $7 million in FY2021, compared to its initial forecast of $186 million in earnings. Its FY2022 earnings forecast is also reduced by 61%.

“Looking ahead, we believe aircraft utilisation would be on a long and uncertain rate of recovery and MRO spend would take an even longer period to recover as airlines are likely to ground older aircraft. While admittedly late in downgrading the stock, we still believe investors might be underestimating the extent and duration of the downturn,” UOB KayHian analyst K Ajith wrote in a May 12 report.

CGS-CIMB Research, however, has maintained its “hold” call for the stock, but reduced its target price to $1.79 from $2.77 previously. The brokerage has cut its earnings per share (EPS) forecast for the company by 74% in FY2021 and 49% in FY2022. It has also lowered its revenue forecast for the company by 50% in FY2021, but kept it flat in FY2022.

CGS-CIMB says it expects earnings contribution from JV and associate companies to fall 40%. “More severe impact will be felt in the subsequent quarters,” CGS-CIMB head of research Lim Siew Khee wrote in a May 12 note.

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