ST Engineering - DBS Research 2016-10-19: One-off charge to impact 3Q 16 profits

ST Engineering - DBS Vickers 2016-10-19: One-off charge to impact 3Q 16 profits SINGAPORE TECH ENGINEERING LTD S63.SI

ST Engineering - One-off charge to impact 3Q 16 profits

  • Closure of Chinese subsidiary JHK results in oneoff charge of S$61m to be taken in 3Q16 results.
  • Net impact to FY16 profits should be ~S$55m (not reflected in our forecast).
  • We believe FY16 DPS should remain unaffected as the charge-off should be largely non-cash.

What's New

Proposed cessation of loss-making Chinese construction business. 

  • ST Engineering (STE) announced that it will likely cease operations at its Chinese subsidiaries Jiangsu Huatong Kinetics Co., Ltd and Jiangsu Huaran Kinetics Co., Ltd – collectively known as JHK – parked under the Land Systems division ST Kinetics. 
  • ST Kinetics owns a 75.3% stake in these subsidiaries. JHK is engaged in the road construction business in China and has been lossmaking for at least the last three years owing to a slowdown in construction activity in China. 
  • JHK’s management has tabled a formal proposal to JHK’s Board of Directors proposing the cessation of business activities, as cash will soon run out. The JHK board, represented by both shareholders – STE and its minority partner Jiangshu Huatong Machinery – has 15 days from today to come to a decision. 
  • ST Engineering expects that a cessation of production activity (i.e. board votes in favour) at JHK is the likely scenario.

One-off charge in 3Q16 expected. 

  • In the likely scenario that production ceases, STE via ST Kinetics will record a S$61m one-off charge in its 3Q16 financials. This includes an impairment charge in the net book value of JHK and closure costs including staff compensation.

FY16 profit forecast to be hit by c.S$55m, but FY17 profitability should see a boost from lower losses. 

  • The one-off charge of S$61m to be taken in 3Q16 represents 12.5% of our net profit assumption of S$485m for FY16.
  • However, the cessation of operations at JHK will lead to lower operating losses going forward from 4Q16 and beyond as annual losses from JHK were estimated to be in the range of around S$20m. Thus the net impact on FY16 results will be a c.S$55m hit to profit, potentially reducing our headline net profit forecast by c.11% from S$485m to about S$430m, while FY17 profitability could see some boost as losses from JHK will no longer be around. 
  • We have not reflected these in our forecasts yet, and will do so in tandem with the upcoming 3Q16 results.

Minimal impact to topline. 

  • The impact to revenues is not material as JHK’s sales figures have been depressed. We estimate the full-year impact on revenue to be S$30-35m arising from the cessation of operations at JHK, which is only 0.5% of both our FY16 and FY17 revenue forecasts.

We believe STE will maintain dividend payouts. 

  • Despite dividends typically being pegged to a payout ratio of 80- 90% of net profit, due to our expectation that the oneoff charge is largely non-cash, we are of the view that STE’s dividend payouts will remain unaffected, and thus we are likely to maintain our forecast of a 15Scts payout for FY16 – in line with last year’s amount – pending the 3Q16 results.

We continue to like the stock for its solid long-term fundamentals. 

  • While we could see some short-term negative impact as a result of this announcement, it is good that STE has bitten the bullet as far as the loss making Chinese construction vehicle business is concerned with the divestment of GJK earlier and now this cessation at JHK, and focus on other growth areas instead. 
  • Investors should look at any share price weakness as a good entry point for STE given that 
    1. the current macro environment favours defensive stocks such like STE; 
    2. STE has a solid orderbook covering almost two years of sales; 
    3. its balance sheet remains strong and 
    4. we remain confident in the long-term prospects of the company, with its focus on aerospace MRO and smart city solutions. 
(Maintain BUY, TP $3.55)

Suvro SARKAR DBS Vickers | http://www.dbsvickers.com/ 2016-10-19
DBS Vickers SGX Stock Analyst Report BUY Maintain BUY 3.55 Same 3.550