ST Engineering - DBS Research 2018-05-14: Confidence In Growth Potential

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SINGAPORE TECH ENGINEERING LTD SGX: S63

ST Engineering - Confidence In Growth Potential

• 1Q18 core net profit of US$122m (+23% y-o-y) in line, ST Engineering (STE) should be back on growth trajectory in FY18.
• Orderbook remains at near peak level at S$13.4bn.
• Aero engine workload seems to be trending higher.
• Marine margins in FY18 could be weaker as delivery of problematic ConRo vessel is pushed back slightly.

BUY on multiple re-rating drivers ahead.

• ST Engineering’s (STE) recent share price retreat ex-final dividend payout is a good buying opportunity for patient investors. We like STE for a combination of factors:
  1. award of some of the larger contracts that STE is vying for (e.g. US Postal Service vehicle contract and US Marine Corps contract) are expected to be announced in 2018, providing potential upside catalysts if STE (and partners) are chosen;
  2. improved visibility from STE’s target to more than double smart city revenues by 2022 and grow other segment revenues at 2-3x the global GDP growth rate;
  3. Aerospace segment rebound, with margins improving this year on stronger CFM engine MRO demand, and in the longer-term, sizeable contribution expected from P2F programmes currently in ramp-up phase;
  4. expected deliveries of the two problematic ConRo vessels in 2Q/3Q18 which should help shipbuilding turn profitable, though it is slightly delayed than expected. Meanwhile, dividend yield is around 4.5%, which should provide support to the stock price. 

Where we differ:

• 1Q18 was a quiet quarter with no unexpected contract wins, and earnings are typically seasonally lower as well, which leads to some sell off in the market. But we think STE is at the cusp of a ‘next leg up’ in its growth story while trading at reasonable valuations (just below mean historical P/E), with a 4.5% dividend yield to boot, which makes it attractive. 

Potential catalyst:

• Significant order wins, turnaround at US shipbuilding operations, and progress with smart city initiatives. 

Valuation: 

• Our Target Price of S$4.10 is based on a blended valuation framework, which factors in both earnings growth and long-term cash-generative nature of STE’s businesses. 
• (Maintain BUY)

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 - 1Q18 core profits in line 

Core PBT and net profit in line with expectations:

• Excluding the c.S$4.8m effect of a realised foreign currency translation loss on the dissolving of two US legal entities Dalfort LP and Dalfort GP, PBT was c.S$149m for the quarter, which was broadly in line with expectations. 
• Reported PBT of S$144m was in line with expectations, representing 12% y-o-y growth on a restated basis (on adoption of new SFRS(I) rules), and accounting for roughly 22% of our full-year net profit estimates, which is in line with the usual seasonality. 
• Revenues improved 9% y-o-y to S$1,647m. Core net profit (similarly excluding the Dalfort translation loss) came in at S$122m, which is almost 23% higher y-o-y, representing around 22% of our full-year net profit estimates. 

Less visibility on sub-segment profit trends for now, owing to change in reporting from PBT to net profit.

• At the more detailed sub-segment level, ST Engineering seems to have shifted its reporting focus from profit before tax (PBT) to net profit (PATMI), which makes sub-segment comparison (for e.g. Aircraft Maintenance & Modification sub-segment within the Aerospace segment) in terms of historical trends challenging this quarter. 
• Q-o-q comparisons are also less meaningful due to the restatement of financials in line with SFRS(I) adoption and the lack of restated financials for 4Q17 at this point. 

Marine segment earnings recovery pushed back on ConRo delivery delay.

• While we had previously expected the two problematic ConRo vessels being built by ST Marine’s US shipyard operations to be delivered in 1Q18, thus relieving the shipbuilding sub-segment of additional provisions, we understand the first ConRo vessel is now scheduled for delivery at the end of 2Q18 and the second vessel should be delivered in 3Q18. 
• To recap, these two vessels were the drag on the Marine segment’s shipbuilding operations; shipbuilding would have been profitable in 1Q18 if not for provisions on the ConRos. 

PBT margins generally in line, save for a cyclical low in Electronics margins.

• Group PBT margins came in at 9% excluding the effect of the Dalfort translation loss. 
• Segment-wise, PBT margins were generally in line with our full-year estimates, save for the Electronics segment which saw a weaker 1Q18 PBT margin of 8%, though the company has attributed this to seasonality affecting the sales mix, and they expect PBT margin to improve in subsequent quarters with a view towards achieving the usual 10% PBT margin for the full year. 

Engine workload trend looks promising.

• Management said that ST Aerospace’s engine shops are experiencing high utilisation rates, with an uptick in shop visits felt since last year, which has continued into 2018. Problems with the new Airbus NEO and Boeing MAX aircraft variants have delayed their entry into service, pushing back the retirement of some older aircraft, which is positive for MRO work in general. 
• Meanwhile heightened checks on the CFM56-7B engines following the Southwest aircraft explosion has boosted workload on that front. 

Orderbook remains robust.

• Orderbook remained flat q-o-q at S$13.4bn which is near historical peak levels. Announced order wins of S$1.14bn from the Aerospace and Electronics segments in 1Q18 were in line with previous year’s amounts. 

Net cash balance sheet; higher spend on growth projects (otherwise on dividends) would be positive.

• Balance sheet remains healthy; M&A or higher dividends would be a positive. 
• On the back of strong OCF and minimal capex for the quarter, ST Engineering is now back in a net cash position (from 0.05x net gearing in 4Q17). 
• We think higher spending on M&A (at a reasonable price of course) would be positive for ROE, otherwise higher dividend payout would be a plus point too. 

Suvro Sarkar DBS Vickers | Glenn NG DBS Vickers | https://www.dbsvickers.com/ 2018-05-14

SGX Stock Analyst Report BUY Maintain BUY 4.100 Same 4.100