ST Engineering (STE SP) - UOB Kay Hian 2016-11-11: 3Q16 Cleaned House; Time For A Fresh Start

ST Engineering (STE SP) - UOB Kay Hian 2016-11-11: 3Q16: Cleaned House; Time For A Fresh Start SINGAPORE TECH ENGINEERING LTD S63.SI

ST Engineering (STE SP) - 3Q16: Cleaned House; Time For A Fresh Start

  • With the divestment of JHK, STE can now commence operations on a clean slate and we expect lower provisions in the coming quarters. 
  • We also believe the worst is over for ST Marine as it has reduced its exposure to the O&M sector and controlled costs. 
  • We believe STE’s confidence in its new initiatives is also partly behind the attempt to “defend” its final dividend payout. 
  • We recommend investors stay invested as earnings volatility has likely peaked. 
  • Maintain BUY. Target price: S$3.42.


RESULTS


3Q16 headline net profit dropped 42% as ST Kinetics exits China; expects to maintain dividend payout. 

  • Excluding a S$61m charge on cessation of Chinese land systems unit JHK (which was guided previously), ST Engineering’s (STE) 3Q16 net profit would have risen 3% yoy. 
  • Earnings were within expectations as 9M16 net profit amounts to 70% of our full-year estimates (64% of consensus). 
  • Management remains committed to “defending” the 15 S cents dividend payout as the S$61m charge is not indicative of operating earnings. 
  • Orderbook was marginally lower at S$11.4b in 9M16 (2Q16: S$11.6b). Advance payments totalled S$1.5b, slightly lower than the S$1.6b as at 9M15.

Marine: Turnaround was the key positive. 

  • This was mainly due to an increase ship repair revenue as defence-related ship-repair work performed for an overseas navy boosted margins, leading to a S$11.7m (+92% yoy) increase in PBT. 
  • Meanwhile, the shipbuilding segment benefitted from cost rationalisation and product diversification, which led to a S$8.6m (+667% yoy) increase in PBT. STE indicated it is diversifying away from OSV shipbuilding and venturing into oceanographic research vessels. 
  • There were also sequential improvements in ST Marine’s PBT for two quarters.

Land Systems: PBT would have risen 20% yoy, excluding the S$61m provision.

  • With the disposal of the Chinese unit, the land systems division will be exiting China's commercial business. But its speciality vehicle business in the US fared well, leading to a 26% yoy rise in revenue. The unit could also benefit from greater infrastructure spending in the US and STE indicated its speciality vehicles have a near 70% share of the municipal market.

Aerospace: Excluding EFW, revenue was flat yoy but would have risen 2% yoy if associates’ contributions were included. 

  • The key earnings driver was the airframe maintenance and modification segment, offset by lower engine shop visits. STE purchased an additional stake in EFW (from Airbus) in Feb 16. However, margins for the unit were subpar as it is still in transition phase. 
  • Nonetheless, STE remains confident of its passenger-to-freighter (PTF) conversion programme and expects margins to improve as operations ramp up.


STOCK IMPACT


Committed to “defending” the 15 S cents payout, reflects management’s growing confidence. 

  • This contrasts with STE’s earlier cautious guidance for 2H16. However, STE indicated it was then concerned about the operating environment and the lowered profit guidance was not entirely due to expectations of provisions for impairment. 
  • Given management’s optimistic overtures, we raise our dividend assumption from 12.6 S cents to 15 S cents. At current levels, STE offers 2016F dividend yield of 4.8%.

Stay invested; STE appears to have fully “cleaned house” and can redeploy capital more effectively. 

  • Investments in data analytics, satellite imagery, cyber security and PTF conversion programmes are expected to augment earnings. ST Aerospace’s hangar at Shanghai will also enable it to partake of China’s substantial MRO growth potential.
  • STE’s diverse business units and its exposure to defense and civil works provide a certain degree of hedging against an uncertain business environment. We also believe STE is well positioned for modest long-term growth. For these reasons, we recommend investors stay invested.


EARNINGS REVISION/RISK

  • Minimal changes to our 2016-17 net profit estimates.


VALUATION/RECOMMENDATION

  • Maintain BUY. We raise our fair value to S$3.42 from $3.40 as we raise our 2016 dividend estimate by 2.4 S cents. 
  • We continue to value STE using DDM with a risk-free rate of 2.5% and terminal growth rate of 3.0%. Our target price implies 2017F dividend yield of 4.4%.


SHARE PRICE CATALYST

  • More contract wins.




K Ajith UOB Kay Hian | Sophie Leong UOB Kay Hian | http://research.uobkayhian.com/ 2016-11-11
UOB Kay Hian SGX Stock Analyst Report BUY Maintain BUY 3.42 Up 3.400




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