ST Engineering - DBS Research 2017-11-09: No Visibility On Near-term Catalysts

SGinvestors.io

SINGAPORE TECH ENGINEERING LTD S63.SI

ST Engineering - No Visibility On Near-term Catalysts

• ST Engineering's 9M17 PBT of S$450m at 73% of our full-year estimate; 4Q is usually seasonally higher.
• Management seems more cautious on order win outlook at Electronics and Aerospace segments.
• Marine up q-o-q on lack of provisions at US operations; Land Systems underperforms.

Maintain HOLD with lower TP of S$3.70. 

• In 3Q17, we saw management turn a bit more cautious on the Electronics segment’s growth and margin outlook on a shift in customer’s business models and rising competition. Aerospace segment order wins were also guided to maintain their current run-rates (which are in line with the past few years’ average) over the next 12 months. Thus, the order win outlook for 2018 is tempered down, in our view. 
• While we do like the direction the company is taking – i.e. smart city products, robotics, new growth areas (e.g. aircraft leasing), we think most of these initiatives have yet to gain traction to significantly drive revenues in the near term. 
• For now, we are cutting earnings by 1%/4% in FY17/FY18 to account for margin pressure across the various segments. 
• With near-term earnings growth catalysts absent, and possibility of slightly lower dividends y-o-y as well in FY17, we maintain HOLD on the stock.

Where we differ: 

• At 21x FY18 PE, we think the high orderbook level is priced in at this point – ST Engineering’s (STE) share price and PE valuation tend to track order wins, not orderbook levels.

Potential catalyst: 

• Significant order wins, substantial turnaround at the US shipbuilding operations, or progress with smart city initiatives could give the stock an upward boost.

Valuation

• Our TP is adjusted downwards to S$3.70 in line with slightly lower margin estimates, and is based on a blended valuation framework, which factors in both earnings growth and longterm cash-generative nature of STE’s businesses.

Key Risks to Our View

• A protracted slowdown in shipbuilding and execution hiccups at new business segments could derail earnings. 
• Also, lack of action on the M&A front could lead to inefficient use of balance sheet and lower ROEs in the future.

WHAT’S NEW - 3Q17 results were a mixed bag 

PBT of S$163m largely in line. 

• PBT was down 2.8% y-o-y (stripping out loss on closure of JHK in 3Q16), and up 8.7% q-o-q. Much of the q-o-q improvement in PBT was due to the Marine segment, which turned from a PBT loss of S$8.1m in 2Q17 to S$21.1m profit this quarter. This was mainly on a lack of cost provisions at the shipbuilding business’s US operations (which accounted for the majority of the S$22m shipbuilding PBT loss in 2Q17). 
• 9M17 PBT now accounts for c.73% of our full-year estimates. Bearing in mind some of STE’s segments (Electronics, Aerospace) tend to see seasonal highs in 4Q17, this set of results was largely in line.

Aerospace PBT flattish y-o-y; ramp-up of P2F programmes still key to margin expansion. 

• Aerospace saw 16% lower PBT q-oq of S$66.3m, but 3Q tends to be a seasonal low for the segment; comparing y-o-y, aerospace PBT was up 2%. PBT this quarter was boosted by better performance at the component/engine repair and overhaul (CERO) segment, while Aircraft Maintenance & Modification (AMM) PBT continued to decline. Management said that Aerospace order wins are likely to sustain at current run-rates over the next 12 months. 
• Margin-wise, ramping up the A330-200/300 P2F conversions to ‘serial production’ levels is key, though we think that still seems a while away. 
• Aircraft leasing remains a source of future growth, with two new aircraft added to the fleet this quarter (total five in the portfolio), and a targeted ten to be added in 2018. However, we estimate S$15.5m in PBT per year for 15 aircraft (PBT margin ~35%), which comes up to about 5% of full-year PBT; not a small amount but not a game-changer at this point either.

Electronics segment: Some uncertainty ahead as business models shift. 

• Electronics PBT was up 7% q-o-q and 5% y-o-y. The higher y-o-y profit was mainly driven by revenue growth, with comparable PBT margin of 11.1% y-o-y. However, management seemed more cautious on the outlook for this segment:
  1. the train-related business is seeing a shift in customers and business model towards the 2nd/3rd tier cities and PPP-led projects, which tend to favour lower-cost contractors;
  2. shift in the satellite space towards a high throughput and multiple low-earth orbit satellite model requires more partnership efforts – again a shift in business model, which lowers visibility going forward.

Marine segment – up q-o-q on lack of cost provisions on ConRo vessels. 

• The segment turned from a PBT loss of S$8.1m in 2Q17 to S$21.1m profit this quarter. This was mainly on a lack of cost provisions at the shipbuilding business’s US operations (which accounted for the majority of the S$22m shipbuilding PBT loss in 2Q17). 
• ST Marine continues to be on the lookout for distressed targets that fit synergistically within its portfolio (e.g. the repair yard that was purchased in August for US$25m, which sits next to its VT Halter Marine yard).

Land Systems 3Q17 PBT underperformed; high hopes for the TUG robot. 

• Land Systems PBT of S$15.1m roughly halved qo-q and was down 23% y-o-y (excluding the one-off charge for JHK in 3Q16). This was mainly due to a weak quarter at the Automotive business, which just broke even on a PBT level, on a less favourable sales mix. 
• Management made a presentation on the TUG Autonomous Mobile Robots (AMR) by Aethon, which was acquired in August this year. They expect sales of TUG robots to become ‘material’ ( > S$100m) over time – though the exact timeframe was not specified – and see a global market of about US$1bn for AMRs in 2022. These robots have the advantage of not requiring external guiders (e.g. magnetic strips on the floor) and are able to perform machine-to-machine communications (e.g. opening lift doors).

Orderbook still near record highs. 

• Orderbook remains near recent all-time highs at S$13.3bn, translating to a 1.9x bookto-bill ratio.

FY17 guidance remains unchanged – revenues and PBT to be comparable y-o-y. 

• The guidance implies a stronger 4Q vs. this quarter – which gels with the Electronics and Aerospace segments' traditional seasonal peaks in 4Q.

Suvro SARKAR DBS Vickers | Glenn Ng DBS Vickers | http://www.dbsvickers.com/ 2017-11-09

DBS Vickers SGX Stock Analyst Report HOLD Maintain HOLD 3.700 Down 3.800