UOB Kay Hian 2015-08-17: ST Engineering - 2Q15: In Line But Guidance For A Better 2H Should Generate Interest.

SINGAPORE TECH ENGINEERING LTD S63.SI

2Q15: In Line But Guidance For A Better 2H Should Generate Interest

2Q15 earnings were broadly in line with expectations. STE’s guidance for higher revenue on the back of higher orderbook recognition led us to raise our net profit forecast by 3.1% for the year.
This, along with the higher interim dividend, could lead to greater interest in the stock in the near term.
In the medium term, we are concerned about the operational challenges in both the land system and marine divisions.
Maintain HOLD. Target price: S$3.50. Suggested entry price: S$3.20.

ST Engineering’s (STE) 1H15 net profit formed about 50% of consensus full-year estimate and 46% of our estimate. Operating profit growth improved qoq from an 18% decline to a 1.5% improvement; the comparison is relevant given earlier concerns about cost overruns at the marine division as well doubtful debt provisions.
Improved margin at the Marine division led to yoy PBT improvement for the group but a S$6.4m charge on cross currency swaps resulted in higher finance charges. Consequently, both pre-tax profit and net profit were lower yoy. STE also raised interim dividend payout to 6 S cents from 5 S cents in 1H14.
Orderbook improved by S$0.2b to S$12.4b. During the analysts’ meeting, STE guided for a strong 2H due to higher orderbook recognition.

This was however offset by a steep increase in inventory obsolescence charges at the same division. The division also recognised S$4.0m in goodwill impairment for the period.

The decline in the marine division’s revenue is cause for concern as there are three quarters of sequential decline in shipbuilding revenue, due in part to its exposure to the OSV segment.
The land system division also faces headwinds in China and Brazil, where tough operating conditions and weak demand have led to continued obsolescence charges. The situation is compounded by a weak funding environment in Brazil.

STE indicated that a delay in certification led to maintenance work being held back, while a dispute regarding engine washing with an OEM principal also impacted revenue. These issues had been addressed in STE’s favour.
In the longer term, STE expressed confidence in its recently concluded A320/A321 passenger-to-freighter (PTF) conversion programme in which it has an exclusive partnership with Airbus, with the view that this could potentially cushion some of the cyclical slowdown in airframe maintenance work.
At this stage, we are unsure of the success of the PTF programme, given overcapacity in the air cargo market. Even if demand eventually picks up, we reckon this will only impact earnings in 2017 at best.

Management’s guidance of an improved 2H15 is due to orderbook recognition being skewed towards 2H at a 40:60 ratio. Thus, earnings should improve hoh, provided impairment charges do not escalates.
This could pave the way for higher dividends.
We have not raised our final dividend forecast of 10 cents.
Payout ratio for 2015 is estimated at 88% vs 88.7% for 2014.

The electronics division appears to be the only segment that has less cyclical pressure and thus the ability to deliver growth over the next two years.
A large part of STE’s cost base is fixed, given that its pool of engineers is deemed to be critical to the long-term growth of the firm. Thus, the ability to cut costs amid cyclical weakness could be limited.

We raise our 2015 net profit forecast by 3.1% following management’s guidance for a better 2H.
We also raise our 2016 net profit forecast by 5% after assuming better aerospace growth.

Maintain HOLD. We continue to value STE at 19x 2015F PE but add net cash to our fair value and derive at a target price of S$3.50. Suggested entry price is S$3.20.

K Ajith | http://research.uobkayhian.com/ UOB KH 2015-08-17

HOLD Maintain HOLD 3.50 Up 3.30