ST Engineering - Maybank Kim Eng 2018-08-08: Keep Calm & Carry On

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SINGAPORE TECH ENGINEERING LTD SGX:S63

ST Engineering - Keep Calm And Carry On

2Q18 core profit better than we expected

• Against a backdrop of trade tensions and rising oil, raw material costs, ST Engineering delivered better than expected 2Q18 core PATMI growth of 20% y-o-y, 8% q-o-q. Moreover management indicate some business units could see a better 2H with timing of some contracts pushed back by a few months.
• We remain positive on secular growth in aerospace airframe maintenance and PTF and increasing investment by countries in Smart City solutions.
• Maintain BUY, with DCF based Target Price of SGD4.15 (WACC 8.1%, TG 2%).

Growth driven by better margin work mix

• ST Engineering's 2Q18 revenues were slightly down y-o-y and flat q-o-q largely from the effect of changes made in revenue recognition policy last year. EBITDA grew 11% y-o-y, 13% q-o-q from a better mix of higher margin work in Electronics, Land Systems segments while Marine experienced a turnaround to the black from provisions taken on US shipbuilding contracts last year.
• Group pre-tax margin in 2Q18 improved 100bps y-o-y to 9% (flat y-o-y for 1H18).

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Outlook positive for three of the four businesses

• Aerospace is seeing engine shop visit growth with rising air traffic, particularly in APAC, and while PTF (passenger to freighter conversion) has been soft YTD, we foresee a pick-up in the coming months with execution of existing contracts as well as customer options being exercised.
• Electronics continues to see Smart City & transport related new orders with recent wins in Taiwan, China, Singapore and Middle-East.
• Land Systems recently lost a potential contract from US Marine Corps to a competitor but the pipeline of speciality vehicles, weapons & munitions and robotic solutions projects remains strong.
• Marine is the only segment that remains challenged facing soft demand for shipbuilding and repair.

Continuing to invest, trade-spats notwithstanding

• ST Engineering continued to invest in capabilities and capacity in 1H18 with a new aerospace facility in Pensacola (USA) with UPS as the launch customer and a second panel manufacturing second plant in Germany ahead of the expected ramp up in aircraft deliveries from customer Airbus.
• While management are keeping a close eye on the US-China trade war, they do not envisage any significant impact on their businesses at this point.

2Q18 results summary and key points

• ST Engineering's 2Q18 revenue -6% y-o-y, EBITDA +11%, reported PATMI +5% and core PATMI +20% excluding restatement for 2017 for IFRS 115. Including IFRS 115 restatement for 2017, PATMI +10% y-o-y, core PATMI +25%.
• ST Engineering's 2Q18 core PATMI levels slightly better than expected with 1H18 accounting for 47% of our FY18E core profit forecast.
• Reported PATMI profit grew for all divisions: Aerospace +26% y-o-y, Electronics +22%, Land Systems +3%, Marine a turnaround from losses.
• Key exceptional items in the quarter were
  1. early redemption of an SGD500m MTN facility resulting in SGD15.3m in charges and an SGD4.4m loss in related liquidation of bond investments – management state that the early redemption will result in c.SGD33m savings in interest costs over next 12 months,
  2. SGD9m gain on disposal of an associated investment and,
  3. SGD10.8m charges in inventory obsolescence.
• Order book remained unchanged q-o-q at SGD13.4b (all time high). Commercial: Defence revenue split 72%:28% (1Q18 63%:37%).
• Interim dividend of 5cts/share unchanged y-o-y.

Investment thesis

• After three lacklustre years (tough market conditions in three of its four operating divisions as well as one-off restructuring costs in various Land Systems/Marine units), the growth outlook for ST Engineering appears brighter with cyclical recovery in some of its segments and catalysts from new investments finally falling in place:
  1. The aerospace MRO landscape has been improving since mid-2017 - particularly so for freighter conversions as the modest surplus capacity of 2016 has been mopped up by the global trade rebound seen in 2017. Market conditions are also supportive of conversions versus newbuild - ready stock of mid-life aircraft available and long lead times required for newbuild as Boeing & Airbus have order backlogs that are equal to almost 10 years of production.
  2. Outlook for its electronics division robust with growing demand for smart-city infrastructure (i.e. smart street lighting, water management, metering, cyber- security etc) and a fast expanding VSAT solutions market (ST Engineering is amongst the largest five VSAT solutions providers globally).
  3. Recent acquisitions like SP Tel and Aethon add capabilities to tap high growth in enterprise ICT, cyber security solutions and the autonomous robot market. Aethon in particular opens up a new market for ST Engineering; its TUG(R) robots are in pilot tests this year in three Singapore hotels and have broad based application potential in hospitality, healthcare, logistics and manufacturing sectors. This is not beta testing as the product has already been deployed in 200+ customer sites (including 140 hospitals in the US).
  4. Cost rationalization / write-off / impairment in problem areas of Land Systems and Marine businesses is largely done. In our view, even without our revised outlook for higher growth in Aerospace and Electronics, ST Engineering would revert to mid - single digit core profit growth without the prior drag from these areas.

Forecasts & valuation

• We forecast a core profit CAGR of 11% for FY17-20F on the back of revenue CAGR of 7% over the period. Our profit forecasts are 2-15% above consensus.
• We expect this resumption of growth from four 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.
• Our price target of SGD4.15 is based on DCF assuming 8.1% WACC, 2% TGR, and 20% ND/E.

Key risks

• 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.

Neel Sinha Maybank Kim Eng Research | https://www.maybank-ke.com.sg/ 2018-08-08

SGX Stock Analyst Report BUY Maintain BUY 4.150 Same 4.150