ST Engineering (STE SP) - UOB Kay Hian 2017-08-14: 2Q17 In Transition Phase, Troubles At Marine Division Likely To Have Peaked

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SINGAPORE TECH ENGINEERING LTD S63.SI

ST Engineering (STE SP) - 2Q17: In Transition Phase, Troubles At Marine Division Likely To Have Peaked

• In 1Q17, ST Engineering (STE)’s earnings were impacted by a $14m provision in doubtful debts at the ship repair segment, while 2Q17 saw cost overruns at the shipbuilding segment. We believe that 1H17 is likely to have been the worst for the division. 
• While we are encouraged by STE’s new investments, these will take time to bear fruit. For the next 2-3 quarters, we remain neutral on the stock. 
• Maintain HOLD with a lower target price of S$3.80. Suggested entry is near S$3.50.

RESULTS

Marine division was the main drag but likely to improve in the coming quarters from lower provisions. 

• ST Engineering’s (ST) marine division shipbuilding pre-tax losses amounted to S$22m, the bulk of which was due to provisions made on two LNG-powered ConRo (container roll-on roll-off) vessels. The provisions relate to cost overruns incurred from design variations as well as one month of work stoppages due to poor weather conditions. 
• Aside from cost overruns, shipbuilding revenue fell 34% yoy partly due to lower milestone completions. The 2 vessels are already 95% and 73% completed, one of which will be delivered in 2H17. As such, further provisions, if at all, are unlikely to be material. 
• ST Marine also reduced headcount during the period and staff cost fell 9% in 1H17. ST Marine had also mothballed 2 yards. There is also a possibility of writebacks from doubtful debts.

Lowered guidance to “comparable” for 2017 PBT, entirely due to poor outlook of the marine division. 

• STE indicated that it had not changed its outlook on the remaining sectors and it appears that STE is downplaying expectations. 
• Meanwhile, STE intends to focus on the ship repair segment which fared relatively better and indicated it was also bidding for large defence contracts which could pick up on higher US military spending.

Aerospace’s 6% rise in PBT was mainly due to a doubling in the EMS profits.

• Notably, the rise in engineering & material services (EMS) segment PBT was greater than the increase in revenue. Meanwhile, aircraft maintenance & modification (AMM) PBT declined 30% yoy due to the lack of contribution from a major conversion project.
• However, we also note that revenue out of the US fell by 14%, suggesting weakness at its core aircraft maintenance business in the region. 
• Going forward, STE remains optimistic of its passenger-to-freighter (PTF) conversion programme and highlighted the contract win from DHL for an additional 4 A380 PTF and an option for 4 more during the period.

Excluding prior year’s S$10m disposal gains, Land Systems PBT would have risen 45% yoy. 

• This was due to higher PBT from munitions and weapons (M&W) segment, while core auto PBT would have risen almost three-fold to S$11.2m excluding the prior year’s divestment gains on its Chinese land systems unit, GFK. 
• STE indicated that the higher M&W PBT was due to a new contract win for 40mm munitions.

Electronics segment revenue rose 40% partly due to a change in accounting treatment, but PBT rose only 2% yoy. 

• STE attributed this to unfavourable sales mix, as well as a weaker 1H for its satellite business. Electronics PBT margin was only 8.3%, vs 10.9% in 2016. However, STE guided that it expects margins to improve in 2H16 and a pick up in its satellite business.

Operating cash flow turned negative on higher trade receivables. 

• Trade receivables rose by S$301m in 2Q17, amounting to 21% of COGS. STE indicated that they have a robust credit policy and highlighted that none of the increase in trade receivables were due from the marine division. 
• Still, it would be not too surprising if the higher trade receivables lead to doubtful debt provision in the coming quarters.

STOCK IMPACT

• Long road ahead for marine division’s earnings recovery but unlikely to swing into further losses as STE has cut capacity and workforce.

Long-term prospects intact as evidenced by significant investments in strategic areas. 

• Specifically, STE highlighted that its acquisition of:
  1. SPTel's fibre optic grid assets,
  2. proposed S$50m acquisition of autonomous mobile robotics company, Aethon, and
  3. US$150m Corporate Venture Capital (CVS) as renewed areas of focus. 
• The CVS units will invest in companies that complement and strengthen STE's current businesses.

EARNINGS REVISION/RISK

• We lower our 2017 net profit estimate by 6% as we factor in STE’s lowered guidance and provisions at the marine segment. Excluding the prior year’s impairment, our 2017 numbers imply a core PBT growth of 6% for 2H17.

VALUATION/RECOMMENDATION

• Maintain HOLD with a slightly lower target price of S$3.80 (Previously: S$3.90). 
• We continue to value STE using a long-term ROIC of 14.6%, WACC of 5.9% and long run growth rate of 2.4%. 
• Suggested entry price: S$3.50.

SHARE PRICE CATALYST

• New contract wins.

K Ajith UOB Kay Hian | Sophie Leong UOB Kay Hian | http://research.uobkayhian.com/ 2017-08-14

UOB Kay Hian SGX Stock Analyst Report HOLD Maintain HOLD 3.80 Down 3.900