ST Engineering (STE SP) - DBS Research 2018-03-23: Investor Day Takeaways; Greater Visibility On Growth

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SINGAPORE TECH ENGINEERING LTD S63.SI

ST Engineering (STE SP) - Investor Day Takeaways; Greater Visibility On Growth

• Raising Target Price to S$4.10 on stronger growth outlook in the medium term; Group-level revenue and net profit implied to grow between 7.5% to 10.0% CAGR over 2017-2022 based on management guidance
• Smart city revenues to more than double by 2022 compared to 2017 levels.
• Aerospace: A330 and A320/321 P2F programmes to reach steady-state revenue of S$400m p.a. by 2022; leasing fleet to grow to over 50 aircraft.
• Marine: targeting to recover to 2013-2014 revenue levels by 2022.

What's New

• In the inaugural investor day held by ST Engineering (STE) recently, management provided more details on the various strategic levers at their disposal to fuel future growth. Ambitious targets were set for revenues and profits with a 2022 timeline. 
• We like the increased clarity on smart city projects’ contribution to the topline and the communication of growth projections for that business line. While we are keeping our near-term forecasts unchanged, we think that STE’s growth will accelerate towards the end of the guidance period in 2022, as business lines like Smart City and Passenger-to-Freighter (P2F) conversion programmes gain traction. 
• We incorporate the higher-than-expected growth into our blended valuation (raising P/E peg from 20x to 22x and incorporating FY22F growth targets into our DCF, partially offset by higher capex to fund growth), raising our Target Price to S$4.10. Maintain BUY.

Key takeaways from investor day: 

Based on guidance, we calculate revenue and net profit CAGR target of between 7.5%-10.0% over the next 5 years. 

• ST Engineering (STE) has for the first time put a number to its Smart City business – S$1bn in revenues in 2017. They expect this to more than double by 2022. Meanwhile, non-smart city revenues (i.e. all other segments) are targeted to grow at a CAGR of 2-3x the global GDP growth rate over that same time frame. Assuming 3% global GDP growth rate (average of World Bank’s global GDP forecast from FY18-20), we calculate that this implies a target of 7.5%-10.0% CAGR for both revenues and net profits for the Group.
• Management believes organic growth alone is enough to get them to the lower level of the forecast (i.e. non-smart city growing at 2x global GDP growth rate), and acquisitions will help boost that further. In terms of geography, twothirds of the revenue growth is expected to come from global markets (non-Singapore).

Growth will likely be back-loaded, near-term forecasts largely unchanged. 

• Given that the growth targets based on guidance implies that 25-35% of the incremental growth will come from smart city projects, we expect the growth is probably back-loaded towards the end of the forecast period, as we think various smart city initiatives are still in their ramping-up stages. We therefore think our c.5% per annum growth assumptions for revenue and c.6% for net profit in FY18/19F are reasonable.

Defence Exports touted as a growth lever. 

• ST Engineering (STE) is projecting US$1.7tn global market for defence annually. The US and the Middle East were cited as key opportunities for defence exports. The US is already the largest defence market, with steady growth, while the Middle East is expected to grow at c.9% per annum going forward. The Group will also continue to target Latin America, Europe and the Rest of World. 
• STE showcased a range of defence products, which included their smart soldier system – a range of wearable infantry products that give soldiers on the ground more situational awareness and improves war-fighting capabilities, and unmanned aerial, ground and sea-going vessels. 

Aerospace: new P2F programmes to hit > S$400m annual revenues in steady-state. 

• While the segment’s legacy conversion programmes (e.g. 757-200) are at their tail end, the new A321/320 and A330-200/300 P2F programmes are gradually ramping up, and STE expects these programmes to contribute over S$400m per annum by 2022 when they are in steady-state. 
• On margins, it was mentioned that Aerospace margins were highest when the legacy 757 and MD11 programmes were at their peaks in terms of aircraft converted annually, and management alluded that margins should likewise be given a boost when the new P2F programmes hit steady state.

Aerospace: leasing fleet to grow to more than 50 by 2022.

• To recap, ST Aerospace is focusing on acquiring mid-life aircraft rather than newer aircraft, which enables them to lower their asset purchase price and leverage their MRO capabilities to keep these older aircraft in shape. The fleet is expected to expand from the current 5 to over 50 by 2022.
• STE will extract value not just from the leasing profits but also from asset management, MRO work, and either partout or P2F conversion. We had previously estimated that each aircraft could contribute ~S$1m in PBT from leasing profits alone.

Marine: expect revenue to recover to 2013-2014 levels by 2022. 

• This implies a doubling of revenues from 2017 levels.
• Based on our understanding, the potential drivers of this are: 
  1. growth in the environmental engineering business;
  2. growth in recurring parts of the business (e.g. ship repair); 
  3. inorganic expansion (e.g. recent acquisition of rig repair yard in the US);
  4. an upswing in global naval shipbuilding beginning in 2020 and accelerating in 2021/22;
  5. growing their product offerings (one example given was the conversion of Platform Supply Vessels which serve the oil & gas industry to Service Operation Vessels, which are used for offshore wind farms).

Cost savings from shared services. 

• ST Engineering (STE) expects a cumulative S$150m in net cost savings over the next 5 years from amalgamating its shared services functions within the Group.
• Capex estimated at S$300m per year over the next 5 years. This number only refers to capex driving organic growth.

Orderbook: S$3.8bn to be recognised in FY18. 

• ST Engineering (STE)’s orderbook timeline is generally between 3-5 years and about 60% of yearly revenue comes from the orderbook. 
• In 2018, management estimates about S$3.8bn to be recognised from the orderbook of S$13.2bn as of 4Q17.

Growth vs. gearing: 

• Management struck a relatively conservative tone with respect to questions regarding taking on higher leverage in our view. Despite low net gearing of about 0.1x, and ambitious growth strategies, they do not expect a “seismic” change to the balance sheet.

Impact of higher steel prices on US projects is minimal:

• The US Postal Service project (if awarded to STE) would use domestic steel and aluminum, so minimal impact.
• The Terrex 2 project (if awarded) plans to import armoured steel from Europe. Discussions are ongoing with the US Marine Corps regarding how this can be resolved, but nonetheless overall impact is very limited.
• For Marine, there are four ongoing projects in the US, all of which have either purchased the required steel, or have committed prices in place with the vendors. For future projects, higher steel prices will be built into the contracts.

Suvro Sarkar DBS Vickers | Glenn Ng DBS Vickers | http://www.dbsvickers.com/ 2018-03-23

DBS Vickers SGX Stock Analyst Report BUY Maintain BUY 4.10 Up 3.900