ST Engineering (STE SP) - UOB Kay Hian 2018-03-23: Expects To Grow At 2-3x Global GDP Growth; Upgrade To BUY

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SINGAPORE TECH ENGINEERING LTD S63.SI

ST Engineering (STE SP) - Expects To Grow At 2-3x Global GDP Growth; Upgrade To BUY

• ST Engineering (STE) guided for smart city and marine revenue to double over the next five years.
• Excluding the former, the rest of the businesses are expected to grow 2-3x faster than global GDP growth over the next five years. We believe that STE’s optimism is due to recent contract wins and global expansion plans. If such overseas contract wins materialise, then STE could morph into a growth stock. 
• Upgrade to BUY with a target price of S$4.10.

WHAT’S NEW

5-year plan could see revenue rising at 8-10% CAGR. 

• ST Engineering’s (STE) CEO Vincent Ng outlined his 5-year plan, which involved three-pronged strategies:
  1. to strengthen the core business; and
  2. to pursue growth opportunities in defence export and the smart city segment; and
  3. to improve margins through cost optimisation.
• Specifically, STE expects smart city related revenue to more than double in five years from S$1b currently. He also expects ST Marine’s revenue to return back to 2012-13 levels, which implies revenue doubling over a five-year period. STE also stated that twothirds of the revenue growth should be from global markets.

Net profit to grow in tandem with revenue. 

• While STE did not provide specific growth figures, the implication is that margins will be maintained. STE was queried as to whether there was scope for margin expansion given the likely operating leverage from increased scale but was non-committal. 
• Although STE indicated that reduction in overhead costs, efficiency improvement and increased collaboration with strategic partners could result in a targeted S$150m cost savings by 2020. If so, and based on the above base case scenario and conservatively assuming flat net profit margin, STE’s net profit could grow at a 7.8% CAGR or 10% in a bullish case.

What’s the cause for the optimism? 

• First, STE indicated that the projections are based on probability assumptions on overseas growth opportunities pertaining to defence export and smart city applications. 
• Second, STE also believes that the marine sector is at the tail end of the downcycle and that revenue should return to that of the previous cycle peak in 2012-13. 
• Lastly, we believe that STE has received contracts for smart city solutions and services from the Singapore government and is optimistic of exporting the same to overseas market.

Smart city applications to be key growth lever. 

• STE focuses its smart city solutions in three key areas: 
  1. Smart security - Cyber security and public security. We believe that STE has already secured cyber security related contracts but the orders might not be disclosed. An example is the “Black Computer”, which might already might be used at government agencies. The computer provides a secure intranet which will be immune to internet viruses. Other applications for public security are the use of drones for parameter security, vessel tracking, counter-drone system etc at key installations. Unlike some of its competitors, STE is able to provide both front-end solutions and provide back-end support. The latter should provide recurring income.
  2. Smart environment. Areas of applications range from automated water meter reading, smart lighting control, congestion management and waste sensors. STE believes that overseas developed markets present a greater opportunity for growth and aims to form private partnership (PPP) for operations and maintenance. This is expected to lead to recurring income. STE also plans to offer digital solutions through satellite connectivity recently formed a JV with an Israeli company to provide enhanced inflight connectivity for commercial aviation.
  3. Smart mobility. Focus areas are the use of autonomous vehicles for public transport and smart robots. STE has currently partnered with the LTA for autonomous 4-seater bus development and has conducted trials at Jurong Island. STE expects commencement of feeder and trunk services between 2Q19 and 2Q20. Smart robots meanwhile will be utilised at hospitals, logistics centres and at security installations.

Recovery in marine segment underpinned by two assumptions:

1. A recovery in the US rig count deployment, which will lead to greater demand for support vessels, which is ST Marine’s forte; and
2. higher naval spending. 

• ST Marine’s US Yard is able to contract for the US Navy and the unit is optimistic of securing contracts from a projected 20% rise in naval spending from 2019 to 2023. 
• ST Marine has also secured rig repair assets adjacent to its shipbuilding yard at Pascagoula and will thus benefit from a recovery. ST Marine has also gained capabilities in building LNG powered tug barges and container roll on – roll off (ConRo) vessels. Based on these, ST Marine hopes that revenue will return to 2012-13 peak levels in 2022.

STOCK IMPACT

Clear pipeline for growth, partly supported by orderbook. 

• We believe that the current orderbook of S$13.2b does not fully reflect recent contracts. We also believe that management’s optimism is supported by rapidly evolving industry dynamics. When we downgraded the stock to HOLD, we were awaiting earnings fruition from the enhanced capabilities. 
• STE’s guidance for revenue growth has addressed that concern. Even, if earnings grow at half the implied revenue guidance, it will be a significant trend reversal.

Asset turnover and ROA/ROE for smart city segment could improve significantly and boost group ROA/ROE and ROIC. 

• While we are unsure of the smart city’s segment’s asset or capital base, we believe that it is asset light and would generate better returns compared to the other business. STE has indicated that it would allocate capital to businesses with higher returns and this strategy could lead to higher EVA and boost shareholder returns.

EARNINGS REVISION/RISK

• We raise our 2018-20 net profit estimates by 2.5%, 9.0% and 18.0% respectively.

VALUATION/RECOMMENDATION

• Upgrade to BUY. 
• We value STE on an EV/Invested capital basis and derive a fair value of S$4.10. At our target price, the stock will be trading at 23x 2019F and 20x 2020F earnings.

K Ajith UOB Kay Hian | http://research.uobkayhian.com/ 2018-03-23

UOB Kay Hian SGX Stock Analyst Report BUY Upgrade HOLD 4.10 Up 3.600