ST Engineering - DBS Research 2018-02-26: More Re-rating Catalysts In 2018

ST Engineering - DBS Vickers 2018-02-26: More Re-rating Catalysts In 2018 SINGAPORE TECH ENGINEERING LTD S63.SI

ST Engineering - More Re-rating Catalysts In 2018

  • ST Engineering's 4Q17 PBT of S$174m was above expectations, as margins surprised on the upside.
  • Aerospace segment seeing tailwinds from higher CFM engine MRO demand.
  • Final dividend of 10Scts declared (bringing total FY17 DPS to 15Scts); yield is healthy at c.4.4%; upgrade to BUY with higher S$3.90 Target Price.



Upgrade to BUY with Target Price of S$3.90. 

  • We turn more positive on ST Engineering (STE) owing to a combination of factors:
    1. valuations have come off from their peak of c.22-23x forward PE, with the current forward PE valuation of c.19.5x providing a more benign entry level;
    2. results of bidding for some of the big contracts that STE is vying for (e.g. US$6.3bn US Postal Service vehicle contract and US$1.5bn US Marine Corps contract) are expected to be announced in 2018, providing potential upside catalysts if STE (and partners) are chosen;
    3. the shipbuilding sub-segment is bottoming out, as the two problematic ConRo vessels with cost overruns should be delivered in 1Q18;
    4. aerospace margins improving this year on stronger CFM engine MRO demand; and
    5. STE’s continued positioning for medium-to-long term growth drivers in smart city and in the aerospace segment. 
  • With margins surprising on the upside in 4Q17, we have raised our FY18/19F EPS by c.7%/5%, bumping up our Target Price to S$3.90. 
  • Meanwhile, dividend yield is around 4.4%, which should provide support to the stock price of ST Engineering.


Where We Differ:

  • We see healthy 2018 revenue and PBT growth, backed by a near-record high orderbook of S$13.2bn, which should help the stock re-rate upwards.
  • Potential catalyst: Significant order wins, substantial turnaround at the US shipbuilding operations, and progress with smart city initiatives could give the stock an upward boost.


Valuation

  • Our Target Price is adjusted upwards to S$3.90 in line with higher PBT estimates, and is based on a blended valuation framework, which factors in both earnings growth and long-term 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 derail earnings. Also, lack of action on the M&A front could lead to inefficient use of balance sheet and lower ROEs in the future.



WHAT’S NEW - Margins and dividend surprise on the upside 


4Q17 profit before tax (PBT) beat expectations. 

  • We note that 4Q tends to be a seasonally strong quarter for ST Engineering, and thus were not too surprised by the c. 6.5% q-o-q improvement in PBT. 
  • On a y-o-y basis, PBT was down 5.3% owing to an exceptionally strong 4Q16 (high base effect). More importantly, given that as of 3Q17, management was guiding for ‘comparable’ PBT in FY17, FY17 PBT of S$623m actually ended up higher, 6% y-o-y – better than our expectations – we see 4Q17 as an earnings beat. This was largely due to margins surprising on the upside across all segments except Marine. 
  • PATMI of S$168.5m in 4Q17 was boosted by a one-off c. S$20m gain on deferred tax liabilities as a result of lowered tax rates in the US, hence the strong c.31% q-o-q increase at PATMI level.

Could the engine MRO cycle be coming back? 

  • The aerospace segment put on a strong showing in 4Q17 with PBT of S$95m, up 43% q-o-q and 10% y-o-y. While this was partially due to a favourable sales mix and lower provisions from stock obsolescence, management also highlighted a significant increase in engine shop visits on the CFM family (which typically powers the narrowbody A320 fleet), with that strong trend continuing into Jan 2018. 
  • To note, SIA Engineering has also recently seen a lift on its engine MRO earnings under its JVs (in particular, the Rolls Royce Trent engines); hence this may point to a cyclical upswing in engine MRO work, which had been lackluster for some time now.

Marine should have bottomed out with delivery of problematic ConRo vessels expected in 1Q18. 

  • The Marine segment saw higher-than-expected costs on its two ConRo vessels being constructed in the US this quarter, and took additional provisions on those vessels, depressing Marine profits for the quarter, which came up to S$0.4m in PBT.
  • However, with the delivery of these two vessels in 1Q18, we think Marine PBT could rebound somewhat in FY18 despite industry conditions remaining weak for the sector in general, on account of lower provisions and cost overruns than FY17.

Final dividend of 10Scts declared, slightly above our expectations. 

  • We had expected a dividend per share of 9.5Scts based on a high-80% payout ratio, but STE chose to be a little more generous in our view, thus bringing the fullyear dividend (including a 5Scts interim dividend) to 15Scts, translating to a healthy 4.4% dividend yield.




Suvro Sarkar DBS Vickers | Glenn Ng DBS Vickers | http://www.dbsvickers.com/ 2018-02-26
DBS Vickers SGX Stock Analyst Report BUY Upgrade HOLD 3.90 Up 3.700



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