ST Engineering - UOB Kay Hian 2016-05-16: 1Q16 ~ Look Beyond The First Quarter; Enhanced Capabilities Will Bear Fruit

ST Engineering - UOB Kay Hian 2016-05-16: 1Q16 ~ Look Beyond The First Quarter; Enhanced Capabilities Will Bear Fruit ST Engineering SINGAPORE TECH ENGINEERING LTD S63.SI 

ST Engineering (STE SP) - 1Q16: Look Beyond The First Quarter; Enhanced Capabilities Will Bear Fruit

  • While earnings were lacklustre, we believe that STE’s diversified business and enhanced capabilities will eventually drive earnings growth vs other industrials. 
  • Much of the negatives pertaining to the marine division have been factored in by the street and earnings growth from the aerospace and electronics division will buffer the downturn in the sector. 
  • However, we lower our target price as we cut our 2016 earnings forecast. 
  • Maintain BUY. Target price: S$3.50.



RESULTS 


 Top-line growth did not filter into bottom line on weak Marine and Land Systems performance. 

  • ST Engineering’s (STE) 1Q16’s earnings were also impacted by a S$9.0m bi-annual Singapore air show expense (offset partially by related revenue at associate level) and a marked-to-market S$12.5m forex loss on US dollar bonds. This was due to a 6 S cent rise in the Singapore dollar. 
  • S$11m in PBT losses in the shipbuilding sub- division and weak performance from the automotive subdivision also impacted earnings. Excluding these, operating margins were flat yoy. 
  • Meanwhile, the aerospace division’s 27% yoy revenue growth did not result in a commensurate flow through to bottom line. Order book stood at S$11.5b, down for three consecutive quarters. 
  • Advance payments from customers however rose 4% yoy to S$1.6b. STE guided for a comparable PBT for 2016, (read +/-15%) but cautioned that a more definitive guidance can only be provided by 1H16.

 Challenging environment for the marine division, but widely expected. 

  • Gross margins halved during the period despite the milestone recognitions of naval contracts, which typically command better margins. 
  • Shipbuilding operations swung to a loss, while margins in the ship repair segment halved. STE indicated that the S$6m in cost savings were achieved during the period by reducing indirect costs. In 2Q16, ST Marine will deliver a naval vessel for the Singapore Navy and that could potentially boost margins. 
  • Still, ST Marine indicated that there could be further provisions in the coming quarters.

 Land systems on the right track, following the disposal of an excavator manufacturing business. 

  • Guizhou Jonyang Kinetics (GJK) was sold to its JV partner and management guided that they will not book a loss on disposal. With the disposal, the risk of further inventory obsolescence will be reduced. With the disposal, ST Kinetics’ sole business in China will be the manufacture of road paving equipment.
  • Sequential decline in inventory obsolescence charges is a key positive.


STOCK IMPACT


Look beyond 1Q16, as STE’s new investments and innovation will eventually pay off, though gestation period could be longer than a year. 

  • CEO designate, Vincent Chong remained bullish on long term prospects and touched on the growing prospects of cyber security, smart nation and data analytic solutions, which are likely to gain traction both domestically and overseas. 
  • ST Aerospace’s purchase of a 55% stake in EADS EFW will provide exclusive rights and know-how on A330 and A320 passenger to freighter (P2F) conversion. The unit is also the sole provider for Airbus panels. Meanwhile the successful selection of the Terrex amphibious armoured personnel carrier for the evaluation phase will add to STE’s clout and open doors to other markets. 
  • On balance, we believe that ST Aerospace will continue to maintain its leadership position, while ST Electronics will benefit from the rapid technological advances in data analytics and cyber security.

Value in the stock with low downside risk. 

  • We believe the market has factored in most of the risk and this is reflected in the PE contraction. However we believe that STE deserves to trade at least near the mean PE valuation of 19.5x, given its enhanced capabilities.


EARNINGS REVISION/RISK

  • We have reduced our 2016 net profit forecast by 4% after adjusting for forex losses and lower revenue from the ST Marine. 
  • Our 2017 forecast remains largely unchanged.


VALUATION/RECOMMENDATION

  • Maintain BUY with a lower target price of S$3.50. 
  • Despite the lower earnings, we believe that STE has the means to monetise its strategic investments and innovations over the medium term. 
  • Valuation is also relatively attractive and we continue to value STE at a conservative 21x forward PE.



SHARE PRICE CATALYST

  • More contract wins.




K Ajith UOB Kay Hian | Sophie Leong UOB Kay Hian | http://research.uobkayhian.com/ 2016-05-16
UOB Kay Hian SGX Stock Analyst Report BUY Maintain BUY 3.50 Down 3.50


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