ST Engineering - DBS Research 2017-08-14: Earnings Miss Creates Profit Taking Opportunity

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SINGAPORE TECH ENGINEERING LTD S63.SI

ST Engineering - Earnings Miss Creates Profit Taking Opportunity

• STE's 2Q17 net profit of S$111.5m (down 12% y-o-y) was below expectations.
• Cost provisions at US shipbuilding operations dragged Marine PBT into the red.
• Orderbook remains elevated at S$13.5bn.
• Interim dividend of 5Scts declared – unchanged y-o-y.

Downgrade to HOLD with TP of S$3.80 on lack of near term growth momentum. 

• While we had previously expected the high orderbook, smart city leverage, as well as a turnaround at the Land Systems segment to help ST Engineering (STE) push past its previous valuation highs, we now believe it could be time for a breather as earnings momentum stalled in 2Q17. 
• The weaker-than-expected showing was due to cost provisions at the US shipbuilding operations and softer-than-expected margins at Aerospace and Electronics segments. 
• We cut our FY17/18F net profit estimates by 12%/ 8%, and management guidance for FY17 PBT has also been lowered from “higher than FY16’s number” to “comparable” currently. 
• With near term earnings growth catalysts absent, and possibility of slightly lower dividends as well in FY17, we downgrade the stock to HOLD.

WHAT’S NEW

Earnings missed estimates on provisions at Marine segment and softer margins at other segments. 

• ST Engineering's 2Q17 net profit of S$111.5m was below estimates. 
• Net profit for 2Q17 was up 7.8% q-o-q but down c.12% y-o-y. 2H17F earnings are now tracking at just c.38.5%/40% of our and consensus’ FY17 full-year forecast (though we note that 4Q usually sees a seasonal upswing). 
• Overall PBT margins came in at 8.5% for 2Q17 and 8.7% for 1H17 – lower than expected. This was largely due to losses at the Marine segment’s US shipbuilding operations, but we are also seeing softer margins at some other key sub-segments such as
  1. Electronics’ communication & sensor systems group, where the satellite business saw a slow start to the year, and
  2. Aerospace’s aircraft maintenance & modification business, which posted a less favorable sales mix in 2Q17 as one of the major 757 conversion programs was completed, and replaced by lower margin heavy maintenance work.

Shipbuilding cost provisions dragged Marine segment down.

• Cost provisions were made on two LNG-powered ConRo vessels under construction at VT Halter Marine, STE’s US shipbuilding subsidiary, which accounted for the majority of the S$22m PBT loss at the shipbuilding business and thus a S$8m PBT loss for the Marine segment as a whole. Without the provisions, both the shipbuilding business and Marine segment as a whole would have been in positive PBT territory.
• Management believes they have made sufficient provisions for these two vessels – which are at advanced stages of completion (> 90% for the first and > 70% for the second).

Full-year PBT guidance lowered. 

• Management has lowered its guidance for the full-year’s profit before tax (PBT) estimates from ‘Higher’ y-o-y previously, to ‘Comparable’ (which is +/- 5% in their parlance). This implies some uptick in 2H17’s PBT, which makes sense given the seasonal upswing usually seen in 4Q, but we now expect full year core net profit number for FY17 to be lower y-o-y.

Orderbook is a plus point. 

• STE announced order wins of S$1.14bn in 2Q17 and S$2.7bn for 1H17, mainly from the Electronics and Aerospace segments. An undisclosed land systems contract secured in 1Q17 (which we estimate at ~S$1bn) also boosted the orderbook to a new high of S$13.5bn, covering about 2 years of revenue. 
• However, with earnings guidance tempered down for FY17 and margins soft, any positive impact on earnings from a strong orderbook looks to be a medium term story.

Interim dividend of 5Scts same as last year’s amount, but final dividend could come under slight pressure. 

• While interim dividend was maintained on the back of healthy cash flows and strong balance sheet, STE could lower final dividend a notch from the 10Scts final dividend it paid last year to around 9.5Scts final dividend for FY17, based on our revised earnings estimates and the payout ratio observed in the last few years. This would equate to a dividend yield of 3.8%.

Where we differ: 

• While we continue to like STE’s long-term prospects, especially its intensifying focus on smart products, and record-high orderbook, we think earnings uplift now looks more like a medium term story and prefer to turn neutral until there is greater visibility on growth.

Potential catalyst: 

• Significant order wins, substantial turnaround at the US shipbuilding operations, or progress with smart city initiatives could give the stock an upward boost.

Valuation

• Our TP is adjusted downwards to S$3.80 in line with the lower earnings estimates, and is based on a blended valuation framework, which factors in both earnings growth and longterm cash-generative nature of STE’s businesses.

Key Risks to Our View

• A protracted slowdown in shipbuilding and execution hiccups at new business segments could detail earnings. 
• Also, continued lack of action on the M&A front could lead to inefficient use of balance sheet and lower ROEs in the future.

Suvro SARKAR DBS Vickers | Glenn Ng DBS Vickers | http://www.dbsvickers.com/ 2017-08-14

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