ST Engineering - UOB Kay Hian 2017-02-17: 4Q16 Full Year Core Earnings Flat, But STE Deserves To Be Re-Rated As A New-economy Firm

SINGAPORE TECH ENGINEERING LTD S63.SI

ST Engineering (STE SP) - 4Q16 Full Year Core Earnings Flat, But STE Deserves To Be Re-Rated As A New-economy Firm

2016 marked a year of transition for ST Engineering (STE) amid extensive impairments and a deep slowdown in the O&G sector. However, it also harkens a new era of technological and engineering prowess, which we believe will bear fruit in the coming years. We believe newsflow will be supportive and that valuation multiples will gradually rise.

We raise our target price by 8% to S$3.70 as we lower our risk premium by 25bp.

ST Engineering’s (STE) land system profit grew 90% yoy due to strong contribution from US speciality vehicles division, which saw better pricing and higher sales.
The electronics division similarly fared better in 4Q16 on the back of broad-based improvement across all segments.
Orderbook stood at S$11.6b (S$11.7b - 2015) with S$3.7b expected to be recognised in 2017.
STE guided for comparable revenue but higher PBT for 2017, but clarified that excluding S$61m in impairment and closure costs for 2016, the comparable earnings for 2017 will vary by +/- 10%.
The final dividend was unchanged at 10 S cents, amounting to a payout ratio of 96%.

The division’s 4Q16 earnings were flat yoy despite the acquisition/consolidation of EFW in early-16. ST Aerospace indicated that newer generation aircraft require less maintenance hours and the expected engine shop visits have yet to materialise.
That said, the company remains optimistic of its aerospace maintenance ventures in Shanghai, Guangzhou and Xiamen. For 2017, STE expects new contracts for A330 passenger-to-freighter (PTF) conversion. We also believe margins could improve for the existing PTF programme with DHL, which commenced in mid-16.

The steep earnings increase came on the back of strong contribution from the US speciality vehicles business which benefitted from hire municipal spending for Lee-Boy road pavers well as an increase in pricing at VT Hackney’s trucks. The US appears to be the sole bright spot in the commercial business currently.
VT Hackney was also one of the six companies short-listed to supply next-generation delivery vehicles for the US Postal Services.

... as outlined in Singapore’s Committee on the Future Economy’s (CFE) recommendations. ST Electronics has a suite of smart initiatives ranging from utility meters, smart street lightings, automatic meter reading for water, electric and gas meters, intelligent traffic and rail transit solutions and robotics.
It is also emerging as a leading player in cyber security with the acquisition of SP Tel, which provides the firm with an extensive back haul infrastructure of fibre-optic connectivity that is critical for cyber security solutions.

STE is not just relevant in the new-economy space but is an enabler of the same. While there have been concerns over its traditional engineering platforms, STE is enhancing its core-capabilities via the above initiatives and investments.
An added incentive is that STE could also benefit if the US reduces its corporate tax rate.

On top of that, its risk profile is substantially lower than other engineering companies, given that working capital requirements are funded via advance payments as well as a recurring backlog of defence contracts.
STE also has a higher ROE than most of its competitors despite lower leverage. We believe STE deserves to trade at a higher PE multiple and on that basis, we lower our risk premium assumption by 25bp to 4.8%.

We raise our 2017 and 2018 net profit estimates by 5% and 4% respectively as we factor in higher margins in the land systems and electronics divisions as well as lower taxes.
We also introduce our 2019 profit forecast.

Maintain BUY. We raise our fair value to S$3.70 (from $3.42) as we lower our COE from 7.4% to 7.1%.
We continue to value STE using DDM with a risk-free rate of 2.5% and terminal growth rate of 3.0%.
Our target price implies 2017F fair-value PE of 21x and dividend yield of 4.1%.

K Ajith UOB Kay Hian | Sophie Leong UOB Kay Hian | http://research.uobkayhian.com/ 2017-02-17

UOB Kay Hian SGX Stock Analyst Report BUY Maintain BUY 3.700 Up 3.420