ST Engineering (STE SP) - 4Q16 Full Year Core Earnings Flat, But STE Deserves To Be Re-Rated As A New-economy Firm
- 2016 marked a year of transition for ST Engineering (STE) amid extensive impairments and a deep slowdown in the O&G sector. However, it also harkens a new era of technological and engineering prowess, which we believe will bear fruit in the coming years. We believe newsflow will be supportive and that valuation multiples will gradually rise.
- We raise our target price by 8% to S$3.70 as we lower our risk premium by 25bp.
4Q16 headline net profit beat expectations mainly due to stronger-than-expected growth at the land system as well as lower taxes.
- ST Engineering’s (STE) land system profit grew 90% yoy due to strong contribution from US speciality vehicles division, which saw better pricing and higher sales.
- The electronics division similarly fared better in 4Q16 on the back of broad-based improvement across all segments.
- Orderbook stood at S$11.6b (S$11.7b - 2015) with S$3.7b expected to be recognised in 2017.
- STE guided for comparable revenue but higher PBT for 2017, but clarified that excluding S$61m in impairment and closure costs for 2016, the comparable earnings for 2017 will vary by +/- 10%.
- The final dividend was unchanged at 10 S cents, amounting to a payout ratio of 96%.
Aerospace: Guidance for comparative PBT; core commercial MRO business said to be challenging.
- The division’s 4Q16 earnings were flat yoy despite the acquisition/consolidation of EFW in early-16. ST Aerospace indicated that newer generation aircraft require less maintenance hours and the expected engine shop visits have yet to materialise.
- That said, the company remains optimistic of its aerospace maintenance ventures in Shanghai, Guangzhou and Xiamen. For 2017, STE expects new contracts for A330 passenger-to-freighter (PTF) conversion. We also believe margins could improve for the existing PTF programme with DHL, which commenced in mid-16.
Land systems stole the limelight with 90% growth in 4Q16; guides for flat revenue but higher PBT.
- The steep earnings increase came on the back of strong contribution from the US speciality vehicles business which benefitted from hire municipal spending for Lee-Boy road pavers well as an increase in pricing at VT Hackney’s trucks. The US appears to be the sole bright spot in the commercial business currently.
- VT Hackney was also one of the six companies short-listed to supply next-generation delivery vehicles for the US Postal Services.
ST Electronics well placed to benefit from smart nation and greater investment in cybersecurity,
- ... as outlined in Singapore’s Committee on the Future Economy’s (CFE) recommendations. ST Electronics has a suite of smart initiatives ranging from utility meters, smart street lightings, automatic meter reading for water, electric and gas meters, intelligent traffic and rail transit solutions and robotics.
- It is also emerging as a leading player in cyber security with the acquisition of SP Tel, which provides the firm with an extensive back haul infrastructure of fibre-optic connectivity that is critical for cyber security solutions.
- STE is not just relevant in the new-economy space but is an enabler of the same. While there have been concerns over its traditional engineering platforms, STE is enhancing its core-capabilities via the above initiatives and investments.
- An added incentive is that STE could also benefit if the US reduces its corporate tax rate.
About 22% of its revenue comes from the US.
- On top of that, its risk profile is substantially lower than other engineering companies, given that working capital requirements are funded via advance payments as well as a recurring backlog of defence contracts.
- STE also has a higher ROE than most of its competitors despite lower leverage. We believe STE deserves to trade at a higher PE multiple and on that basis, we lower our risk premium assumption by 25bp to 4.8%.
- We raise our 2017 and 2018 net profit estimates by 5% and 4% respectively as we factor in higher margins in the land systems and electronics divisions as well as lower taxes.
- We also introduce our 2019 profit forecast.
- Maintain BUY. We raise our fair value to S$3.70 (from $3.42) as we lower our COE from 7.4% to 7.1%.
- 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 fair-value PE of 21x and dividend yield of 4.1%.
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- Contract announcements and US tax rate cuts.