ST Engineering - UOB Kay Hian 2016-08-17: Confident Of Long-term Growth Prospects

ST Engineering (STE SP) - UOB Kay Hian 2016-08-17: Confident Of Long-term Growth Prospects SINGAPORE TECH ENGINEERING LTD S63.SI

ST Engineering (STE SP) - Confident Of Long-term Growth Prospects

  • Despite the lower PBT guidance for 2016, STE remains optimistic of its long-term growth outlook. 
  • STE also highlighted its enhanced capabilities and is optimistic of its PTF business and further inroads for Terrex carriers. 
  • In an environment of weak corporate earnings, we believe STE’s diversified businesses and investment in enhanced capabilities will enable it to weather downturns and deliver growth over the long term. 
  • Maintain BUY. Target price: S$3.60.



WHAT’S NEW 

  • We attended ST Engineering’s (STE) analyst briefing and hosted a luncheon. The takeaways are as follows:

Revised guidance not a reason to SELL; STE is cleaning house. 

  • The guidance for lower PBT for 2016 was mainly due to near-term headwinds at the land system division’s Chinese operations, commercial shipbuilding at ST Marine as well as the general economic malaise. 
  • As at 1H16, STE has rationalised operations by disposing of a Chinese land system subsidiary, Guizhou Jonyang Kinetics (GJK), and reducing headcount at its US marine operations. We also believe STE could sell its Chinese road construction unit, Jiangsu Huatong Kinetics (JHK), with potential losses in the coming quarters. This could be another reason for the lowered guidance. 
  • Management however expressed confidence of its longer-term outlook, due to enhanced engineering capabilities.

Excluding allowance for inventory obsolescence, aerospace PBT would have risen 20% yoy. 

  • STE indicated that the S$12.7m in allowance for inventory obsolescence in 2Q16 was mainly due to mark-to-market pricing of rotables. This was previously done at year-end, but STE adopted a prudent measure by recognising the provision in this quarter. Management also indicated that the provisions are unlikely to rise materially.
  • Excluding the provision, aerospace’s PBT would have grown 20% yoy. However, this included contribution from the new subsidiary Elbe Flugzeugwerke (EFW), which recognised earnings from sale of Airbus panels. STE also attributed the 11% growth in PBT for the aircraft maintenance & modification (AMM) segment to stronger performances from its JVs in China. STE expects electronics division to outgrow aerospace in five years. 
  • The electronics division has been the highest growth division for five years. The division contributes 30% of group PBT but is expected to overtake aerospace (44% of PBT) in five years. STE highlighted its enhanced capabilities, particularly in machine-to-machine (M2M) connectivity and solutions, cyber security, as well as its equatorial satellite. STE guided it has begun commercial sales of its satellite products, which were well received.
  • STE intends to build more satellites in the coming years.

Optimistic of PTF, aircraft leasing business and further inroads for Terrex carriers.

  • STE holds the exclusive intellectual property (IP) for the A330 and A320 PTF conversions and expects the four A330 PTF conversions for DHL to eventually lead to more work.
  • STE is also optimistic of its aircraft leasing business, which specialises in mid- to end-oflife narrow bodied aircraft, and intends to add 4-5 aircraft per year from the current three.
  • The increased scale is expected to boost profitability. STE also showcased the amphibious personnel carrier Terrex at Farnborough. STE is currently in the process of showcasing a variant of the Terrex to the British Royal Navy.
  • STE expects higher capex of about S$300m in 2016 as it invests in its growth businesses, such as PTF, aircraft leasing and data centres.


STOCK IMPACT


Expects similar dividend payout despite lower guidance. 

  • STE did not specify the dividend quantum but we take it that management is confident of a payout quantum close to previous years’ despite the lowered profit guidance. We have assumed a 14-cent dividend in 2016 (2015: 15 cents). 
  • Management remains confident of STE’s long-term growth prospects and is committed to delivering returns to shareholders. In an environment of weak corporate earnings, we believe STE’s diversified businesses and enhanced capabilities will enable it to weather downturns and deliver growth over the long term. 
  • STE currently offers a dividend yield of 4.2%.


EARNINGS REVISION/RISK

  • We lower our 2016 core net profit estimate by 2.3%, in line with STE’s lowered guidance.
  • We have also lowered our 2017 net profit estimates by 3.5%.


VALUATION/RECOMMENDATION

  • Maintain BUY with a marginally higher target price of S$3.60 (previously S$3.50). 
  • We had earlier valued STE at 21.4x PE. We now value STE using DDM with a risk-free rate of 2.5% (previously 3%) and terminal growth rate of 3.3%, and derive a target price of S$3.60. 
  • Our previous PE-based valuation suggests a fair value of S$3.47. 
  • Our target price of S$3.60 implies 2016F dividend yield of 3.9% and PE of 22x.


SHARE PRICE CATALYST

  • More contract wins.




K Ajith UOB Kay Hian | Sophie Leong UOB Kay Hian | http://research.uobkayhian.com/ 2016-08-17
UOB Kay Hian SGX Stock Analyst Report BUY Maintain BUY 3.60 Up 3.500


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