ST Engineering (STE SP) - UOB Kay Hian 2017-05-15: 1Q17 PBT Beat Expectations, Stay Invested For Long-term Growth

ST Engineering (STE SP) - UOB Kay Hian 2017-05-15: 1Q17 PBT Beat Expectations; Stay Invested For Long-term Growth SINGAPORE TECH ENGINEERING LTD S63.SI

ST Engineering (STE SP) - 1Q17 PBT Beat Expectations; Stay Invested For Long-term Growth

  • 1Q17 earnings declined due to lower wage credit income, higher provisions for debt, and higher taxes and minority interest. 
  • STE maintains guidance of a higher 2017 PBT. It highlighted new initiatives, including the development of autonomous buses and further inroads into cybersecurity with a contract from the Sri Lanka government. 
  • We believe STE’s long-term growth prospects remain intact. 
  • We raise our target price by 5% to S$3.90 but downgrade STE to HOLD following a 36% return since our BUY call. Entry price: closer to S$3.60.



RESULTS

  • ST Engineering’s (STE) 6.1% yoy decline in 1Q17 net profit should be viewed in the context of: 
    1. about S$10m reduction in wage credits (the Ministry of Finance reduced the rebate from 40% to 20% in 2017), 
    2. a further provision of S$13.5m in doubtful debts at ST Marine - this included a US$3.3m provision in receivables from Ezra, and 
    3. a 4.1ppt increase in the effective tax rate due to higher earnings at 55%-owned German subsidiary, EFW. 
  • The latter also led to an 11-fold rise in minority interests. EFW manufactures panels for Airbus aircraft and also holds exclusive intellectual property for pax-to-freighter conversions (PTF) for Airbus A330 and A320 aircraft. 
  • Going forward, STE guided for comparable 1H17 PBT, but higher full-year PBT.

Management remains optimistic of long-term growth prospects; orderbook rose 15% from end-16 to S$13.3b. 

  • STE emphasised that its long-term capabilities remain solid, with a slew of initiatives expected to bear fruit over the next few years. 
  • STE pointed out that interest in its cybersecurity solutions can be gleaned from a contract win from the Sri Lankan government to provide consultancy services for its national cyber security operations and an MOU with the Singapore Armed Forces for cyber defense training. 
  • The increase in orderbook, meanwhile, was also due to orders from the Ministry of Defence for next-generation armoured fighting vehicles.


ST Marine: PBT soared 165% yoy due to a recovery in shipbuilding profits as costs de-escalated at the US yard. 

  • While this is positive, STE maintained guidance for lower PBT. ST Marine also recognised S$13.5m in provision for doubtful debts during the period as it reduced its exposure to the oil & gas sector. 
  • ST Marine is still in litigation with Hornbeck Offshore Services and has not made any provision on the US$43.5m claims sought by the latter.

Aerospace: PBT boosted by a 80% yoy rise in Engineering & Material Services (EMS) PBT. 

  • The latter was due to: 
    1. a 10% yoy rise in sales of aircraft panels and components at subsidiary EFW, 
    2. no underperforming contracts, and 
    3. milestone completion of projects. 
  • Going forward, STE remains optimistic of its A330 PTF programme and indicates that the first A330 aircraft is due to be delivered by end-17.
  • Meanwhile, STE will also accelerate the PTF conversions, with an additional aircraft from EgyptAir expected to be inducted next month. While engine profits declined yoy in 1Q17, management opined that it is seeing early signs of a pick-up in engine shop activity.

Electronics: PBT rose 5% yoy, mainly due to stronger profits at Software Systems Group (SSG), offset by lower PBT at Communication & Sensor Systems Group (CSG).

  • STE attributed the latter to lower contribution from iDirect, its satellite-based communications systems unit, but guided that 1Q was a weaker quarter. 
  • Meanwhile, STE maintain guidance for higher electronics PBT for 2017 and highlighted further inroads into cyber security and satellite imagery business, TeLEOS-1.


STOCK IMPACT


Reduced exposure to O&M on track for long-term growth. 

  • 1Q17 earnings were affected by a multitude of factors, notwithstanding the substantial increase in allowances for bad debt. However, STE has substantially reduced its exposure to the offshore and marine (O&M) segment and highlighted several initiatives, including 
  1. commencing operations at its new hangar in Guangzhou, 
  2. developing autonomous buses with the Land Transport Authority (LTA) in Singapore, and 
  3. further in-roads into cybersecurity with the new contract with the Sri Lanka government. 
  • STE also guided that the new contract for maintenance of SMRT’s trains will not require an increase in headcount and it already has the capabilities and technological know-how to provide the services. 
  • Over the long run, we believe STE is poised to benefit from its engineering capabilities and technological enhancements.


EARNINGS REVISION/RISK

  • We trim our 2017 net profit estimate by 1% as we factor in higher minority interest and higher taxes. Our 2018 earnings estimate remains unchanged.


VALUATION/RECOMMENDATION


Downgrade to HOLD with a higher target price of S$3.90; accumulate on dips.

  • Share price has risen 36% since we upgraded the stock to BUY. Valuations appear fair at 22x 2017F PE, a premium to its mean PE and 8% above that of engineering and defence peers. We believe the premium to peers is fair, given its relatively higher ROE, lower-than-peers gearing as well as its long-term growth prospects. 
  • Our target price of S$3.90 implies 22.7x 2017F PE, or 1-SD above mean PE. We now value STE using long-term ROIC of 14.6%, WACC of 5.9% and long run growth rate of 2.4%. 
  • We would prefer to buy closer to S$3.60 for a 10% total return inclusive of dividends.



SHARE PRICE CATALYST

  • New contract wins.




K Ajith UOB Kay Hian | Sophie Leong UOB Kay Hian | http://research.uobkayhian.com/ 2017-05-15
UOB Kay Hian SGX Stock Analyst Report HOLD Downgrade BUY 3.90 Up 3.700



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