ST Engineering (STE SP) - Maybank Kim Eng 2018-03-23: 2018 Investor Day Takeaways

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SINGAPORE TECH ENGINEERING LTD S63.SI

ST Engineering (STE SP) - 2018 Investor Day Takeaways

Reinforcing our bullish view 

• ST Engineering (STE) held its first ever Investor Day for buy & sell side followers of the company – roughly an eight-hour affair with presentations from and interaction with top management of all business areas accompanied by a 117-page slide pack . 
• Sifting through various strategy details, granularity & colour on operations and management’s medium-term outlook, we highlight five guidance details that are new to us. 
• Our positive outlook, forecasts, price target and BUY rating remain unchanged.

Five key guidance trends to be aware of 

• We highlighted the key reasons for our positive view on STE in our recent note ‘ST Engineering (STE SP) - Renaissance Revival’ 12 March 2018. Five details divulged during STE’s 2018 Investor Day that reinforce this view are: 
  • Smart City solutions revenue of cSGD1b to more than double by 2022: Identified as a key growth driver over next five years. This is in line with our thinking but guidance is higher than our expected revenue growth of c55% for the whole Electronics cluster over FY17-FY22F.
  • Core businesses ex-Smart City revenue CAGR at 2x-3x global GDP growth rate (est. c3%) to 2022: Broadly in line (albeit at low end) of our c6% revenue CAGR estimates.
  • Profits to grow in tandem with revenues: We forecast profit growth at c10% CAGR over the FY17-FY22F period vs. revenue growth of c7% from our assumption rationalisation gains.
  • Marine revenue to recover to FY13/FY14 levels by 2022: This is far higher than our expectation; while we expect a stable outlook for Marine, our FY22 forecast is a material c40% lower than FY13 levels. 
  • Efficiency measures to amount to cumulative net saving of SGD150m over five years and cSGD50m annually thereafter: The long term savings gains are higher than our expected cSGD25-30m p.a. run-rate assumed.

Forecasts, valuation and risks 

• We forecast a core profit CAGR of 11% for FY17-FY20F on the back of a revenue CAGR of 7% over the period. We expect this resumption to growth from five key factors: 
  1. The aerospace landscape has been improving since mid-2017, triggered by the rebound in global trade and better-than-expected passenger traffic growth; 
  2. The outlook for its electronics solutions remains robust and could hold an upside surprise with governments increasing investment in smart city infrastructure, i.e. smart street lighting, water management, metering, and cyber-security, etc.; 
  3. Rationalisation of problem areas in its Land Systems and Marine business is largely done and hence operating profit should have a lower drag from these units going forward; 
  4. Recent acquisitions, particularly SP Tel and Aethon are important additions to capabilities for tapping high growth in enterprise ICT, cyber security solutions and the autonomous robot market; 
  5. Greater integration across the business units as well as creation of new platforms to partner start-ups and fund technology gaps (initially seeded with USD150m) should enhance existing capabilities and materially speed up time-to-market for new solutions.
• One other positive factor – although timing is hard to predict as contracts awards take long - is upside from an increase in US defence spending under the Trump administration. STE management is optimistic about defence exports growing in coming years (STE derives c20-25% of revenues from the US market).
• Our profit estimates for the three years are ahead of Bloomberg and FactSet aggregate consensus estimates by 1-15%.
• Our price target of SGD4.15 is based on a discounted cashflow assuming 8.1% WACC, 2% TGR, and 20% ND/E.
• The top-two risks to our forecasts are a material downturn in Aerospace and further write-offs in Marine. Other risks include a global macro downturn that results in cutbacks by governments in urban transport infrastructure and smart city investment and cost pressures arising from rising commodity prices and import tariff regimes in its operating markets.

Swing Factors

Upside

• Higher-than-expected PTF work from airlines upgrading their passenger fleets and cargo growth supportive.
• Better-than-expected margins if aircraft OEMs slow down their aftermarket expansion (as order books are full).
• A meaningful recovery in the marine business from a demand rebound for oilfield services vessels and specialised ship repair Order book growth from US defence and infrastructure project wins, an area that STE has been pursuing but large contracts have been elusive thus far.

Downside

• Intensifying price competition in aerospace driven by smaller players struggling with excess capacity. 
• Structural threat from aircraft OEMs like Boeing and Airbus getting more aggressive in expanding in the aftermarket MRO space.
• Above-norm adverse currency moves and currency volatility against STE’s SGD reporting currency as a large segment of revenues are denominated in foreign currencies.

Neel Sinha Maybank Kim Eng | http://www.maybank-ke.com.sg/ 2018-03-23

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