ST Engineering - UOB Kay Hian 2015-11-09: 3Q15 ~ Results Aided By Forex Gains; Operating Environment Remains Challenging

ST Engineering SINGAPORE TECH ENGINEERING LTD S63.SI

ST Engineering (STE SP) - 3Q15: Results Aided By Forex Gains; Operating Environment Remains Challenging; Downgrade to HOLD

Management’s guidance from a comparable PBT to a lower PBT for 4Q as well as a “challenging” environment for the aerospace and the marine divisions do not aid confidence and suggest 2016 earnings are likely to remain weak.
STE also guided dividend payouts are likely to remain at 75-80%, down from the 88% previously.
Given little near-term catalysts, we downgrade the stock to HOLD with a target price of S$3.25.

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Bottom-line growth in line with earlier guidance but 3Q15 earnings included S$11.7m in positive forex differential vs 3Q14 as well as US$8.8m hedging gains.
Lower taxes at the aerospace division also aided group profitability.
The only segment that fared well on top-line and bottom-line was the electronics segment.
Forex gains and hedging gains amounted to S$16.15m vs a S$3.49m loss in 3Q14.
We believe ST Engineering’s (STE) lowered earnings guidance for 2015 also takes into account the low likelihood of these gains continuing into 4Q.
Orderbook was marginally lower at to S$12.2b vs 1H15’s. Advance payments totalled S$1.6b, slightly lower than the S$1.6b as at end-Sep 14.

FCF for 9M15 was a marginal S$15m vs S$413m in 3Q14. This was due to a substantial increase in capex during the period. As such, we reduce our final dividend payment assumption from 10 S cents to 8 S cents.
Sequential decline in inventory obsolescence was a key positive but this could reverse in 4Q or early-15. However, STE warned operating conditions remain tough for the specialty vehicles segment, particularly in China, thus the possibility of further writedown remains a distinct possibility.
STE also indicated that there is a possibility of impairment of inventory of rotables in Europe if there was a glut of spares.

The decline in marine revenue is cause for concern as there were four quarters of sequential decline in shipbuilding revenue due in part to its exposure to the OSV segment. However, defense-related work for the Singapore and Oman Navy will partially cushion the earnings downtrend.
The land system’s earnings are highly dependent on the operating environment in China where swings in obsolescence and doubtful debts could swing earnings. We believe the trend will persist into 2015.

STE indicated that airlines are increasing utilisation, ie keeping aircraft in the air to boost loads as yields have been under pressure. Still, volume increased, aided by higher engine maintenance but operating margins declined, highlighting ST Aerospace’s greater reliance on airframe maintenance for positive jaws.

We sense management has become increasingly cautious as at 3Q15, citing concern over prolonged softness at the aerospace and shipbuilding divisions. We believe the cautious guidance is likely to extend into 2016.
Amid cautious guidance, STE is likely to at best market perform. Following the lowered guidance, we reduce our dividend forecast by 2 S cents with an implied payout ratio at 78%
Less room for cost cuts as engineers are key assets. The electronics segment appears to be the only segment that has less cyclical pressure and it has several new capabilities which are likely to grow over the next 2-3 years, especially in relation to Singapore’s smart nation initiative. 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 lower our 2015 net profit estimate by 1.6% following management’s guidance for a lower PBT.
We also lower 2016 net profit forecast by 5.8% after assuming lower finance income and higher opex.

Downgrade to HOLD and revise target price to S$3.25.
We roll forward our fair value PE multiple for STE to 2016.
We continue to value STE at 19.5x earnings (long-term mean) inclusive of net cash and derive at a target price of S$3.25. Entry price is S$3.00.

K Ajith UOB Kay Hian | Sophie Leong UOB Kay Hian | http://research.uobkayhian.com/ 2015-11-13

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