One of the most misunderstood things about investing, in my opinion, is risk. That’s because many investors use a stock’s price movement – in other words, its volatility – as a way to measure risk. But doing so may be missing something very important. Billionaire investor Warren Buffett once said that “If a business does well, the stock eventually follows.” He’s speaking to the point about how a stock’s price is ultimately governed by the performance of its business. As such, a focus on a stock’s business fundamentals as a way to gauge its risk may make a lot more…
One of the most misunderstood things about investing, in my opinion, is risk. That’s because many investors use a stock’s price movement – in other words, its volatility – as a way to measure risk. But doing so may be missing something very important.
Billionaire investor Warren Buffett once said that “If a business does well, the stock eventually follows.” He’s speaking to the point about how a stock’s price is ultimately governed by the performance of its business. As such, a focus on a stock’s business fundamentals as a way to gauge its risk may make a lot more sense than fretting over its price-volatility.
With these in mind, just how risky is aircraft repair, maintenance, and overhaul services provider SIA Engineering Company Ltd (SGX: S59) as an investment? There are many other areas of the firm’s business fundamentals to study, but in here, let’s take a look at two important aspects:
1. Balance sheet risk
A weak balance sheet – one that is weighed down heavily by debt – exposes investors to risk by making a company fragile. High levels of debt reduces a company’s ability to weather rough business environments. Even in good times, companies with lots of borrowings may not able to withstand even temporary hiccups. As the legendary investor Walter Schloss once said, “I like to look at the balance sheet and I don’t like debt because it can really get a company into trouble.”
Meanwhile, a strong balance sheet – one that is flush with cash and with relatively little debt – works in an opposite manner. It gives a company higher odds of surviving tough times unscathed and can even allow a company to go on the offensive during downturns and gain competitive advantages over financially weaker competitors that have to batten down their hatches to ride out storms.
In the case of SIA Engineering, its balance sheet looks to be in a healthy state. As of 31 December 2015, the company had S$336 million in cash and equivalents and just S$38 million in total borrowings.
2. Customer concentration risk
A company that depends on just a handful of customers for business can easily run into serious trouble even if just one of them falters or simply walks away.
The experience of GT Advanced Technologies, a sapphire glass manufacturer that was listed in the U.S., is a cautionary tale. Back in late 2014, the firm had to declare bankruptcy after its product had failed to meet the requirements of iPhone maker Apple Inc. At that time, Apple was the likely source of most of GT Advanced Technologies’ revenue.
Coming to SIA Engineering, there may be some cause for concern. In SIA Engineering’s fiscal year ended 31 March 2015 (fiscal 2015), one customer alone had accounted for S$457 million of the company’s total revenue of S$1.12 billion. In other words, SIA Engineering had depended on just one organisation for over 40% of its revenue.
It’s logical and highly likely in my view that this customer is passenger and cargo carrier Singapore Airlines Ltd (SGX: C6L). I say this for two reasons. First, Singapore Airlines is the majority owner of SIA Engineering (a 77.55% stake as of 2 June 2015). Second, Singapore Airlines was the only trade debtor that made up over 15% of SIA Engineering’s total trade debtors in fiscal 2015.
If Singapore Airlines really is that major customer of SIA Engineering, then it’d help reduce some of the latter’s customer concentration risks – the likelihood of Singapore Airlines walking away from SIA Engineering would be low. But, SIA Engineering’s customer concentration risk still looks high to me and that’s because the company is still heavily exposed to the health of Singapore Airlines’ business.
A Fool’s take
To sum up what we’ve seen here about SIA Engineering, the company appears to have low balance sheet risks but a high level of customer concentration risk.
Coming to the earlier question on just how risky SIA Engineering is as an investment, this study of the firm’s balance sheet and customer-concentration dynamics – while very useful – is not sufficient for a firm conclusion to be reached. As I had already mentioned, there are other areas of SIA Engineering’s business fundamentals to consider.
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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore writer Chong Ser Jing owns shares in Apple.