ST Engineering - CGS-CIMB 2018-05-11: Defence Contract Hope

SINGAPORE TECH ENGINEERING LTD SGX: S63

ST Engineering - Defence Contract Hope

ST Engineering’s 1Q18 net profit of S$117.7m (+18% y-o-y, -30% q-o-q) was broadly in line with our and consensus forecasts, forming 21% of our FY18F.
There were more delays in delivering container roll-on roll-off (Conro) vessels but overall marine profit improved q-o-q and unchanged y-o-y, thanks to stronger ship repair.
Aero continued to see good traction in 1Q18 on component & engine repair recovery. No major surprises in electronics; it should continue to see stronger 2H trend.
Order book at S$13.4bn, thanks to sustained order momentum in aerospace and electronics. YTD order win at c. S$1.1bn.

Maintain ADD and target price of S$3.80, on blended valuations (20x CY19F P/E, DCF and dividend yield). Sizeable defence contract win is the key catalyst.

Marine’s 1Q18 PBT of S$9m (4Q17: barely profitable) formed 31% of our FY18F, thanks to strong ship repair, despite losses in shipbuilding.
Delivery timeline for the first Conro dual-fuel (diesel and LNG) vessel was delayed from Mar 18 to Jun 18 due to stringent requirements by the US authority and issues in equipment testing. More provisions were made in 1Q18 (but the extent is less than 4Q17).
We see slight provisions ahead as Conro vessels get delivered but marine’s y-o-y turnaround should be on track.

Aerospace PBT was S$76m, steady y-o-y and down 19% q-o-q on seasonality. PBT margin declined from 14.1% in 1Q17 to 12.7% due to start-up costs for a new facility in Germany under EFW in addition to learning curve for passenger-to-freighter conversion (PTF) projects.
Component & engine division continued to see strong demand for CFM engines shop visits even as operations in Singapore and China are at full capacity. ST Engineering is ramping up more capacity to cope with the demand.
The trend of strong engine maintenance, repair and overhaul (MRO) is likely to last for 3-4 years.

Electronics PBT was at S$48m (+16% y-o-y, -23% q-o-q), in line with our expectations at 21% of our FY18F. PBT margin was steady y-o-y at 8% but ST Engineering guided for annualised margin to reach 10% with stronger 2H18F.
Land system PBT of S$17m (+5% y-o-y, -30% q-o-q) was slightly below expectations at 18% of our FY18F, due to losses in munitions and weapon (-S$1.6m) as projects were delayed to 2Q18 and 3Q18. We think the division will show a stronger 2H18F.

We sensed from management’s tone that it is hopeful of securing an amphibious combat vehicle (collaboration with SAIC) contract with the US Marine Corps. The results will be known by end-Jun/Jul. Winning the contract could instantly lift STE’s global profile in the defence market.
Meanwhile, management cautioned that its contract size for US Postal delivery trucks may be small as the award could be shared by more than one party. The timeline of the award has also been delayed to end-2018 or early-2019.

ST Engineering’s order book stood firm at S$13.4bn at end-1Q18. YTD contract win momentum has been strong, totalling c.S$1.1bn, mainly from aerospace and electronics. This sustains its earnings visibility.
We see opportunity to accumulate the stock on any share price weakness as
1. contract wins,
2. stronger 2H18F could re-rate it.
ST Engineering is trading at 19x CY19F P/E, below its 5-year mean of 20.8x.
Downside risks to our call are execution risks and cost overrun.

LIM Siew Khee CGS-CIMB | https://research.itradecimb.com/ 2018-05-11

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