ST Engineering - UOB Kay Hian 2018-08-10: 2Q18 Impressive Earnings Guide For 29% Growth In Orderbook Revenue Recognition For 2H18

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SINGAPORE TECH ENGINEERING LTD SGX:S63

ST Engineering - 2Q18 Impressive Earnings Guide For 29% Growth In Orderbook Revenue Recognition For 2H18

• ST Engineering (STE)’s 2Q18 core net profit growth was above our expectations of 5-7%. Net profit growth was underpinned by:
  1. strong PBT growth in the electronics division, and
  2. improved profits at the marine division.
• We expect stronger revenue growth in 2H18 due to a 29% y-o-y increase in orderbook revenue recognition. Maintain BUY and target price of S$4.10.

2Q18 RESULTS

Core net profit growth above expectations.

• ST Engineering (STE) restated its 2Q17 net profit downwards by 4.3% due to the adoption of new accounting standards, which mainly impacted the electronic segment. 2Q18 net profit growth was underpinned by:
  1. strong PBT growth in the electronics sector (+25.5% y-o-y);
  2. marine sector’s PBT of S$10.1m, reversing from a loss in 2Q17; and
  3. divestment gains of S$9m from associate Airbus Helicopters.

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• ST Engineering also recognised a breakage fee of S$15.3m in 2Q18 due to redemption of a medium-term note (MTN). Excluding the latter two, core net profit rose 14.8% y-o-y. However, we note that this is partly due to a low base in 2Q17 when STE recognised S$22m in ConRo vessels-related provisions. ST Engineering declared an interim dividend of 5 S cents, unchanged from 1H17’s.
• Orderbook remained flat q-o-q at S$13.4b but STE expects to recognise 29% higher revenue from orderbook related revenue in 2H18.
• On that basis, we assume a y-o-y growth in revenue for 2H18.

Aerospace division: 11% growth in PBT, driven by higher engine & components profit (+158% y-o-y) and S$9.0m gains from disposal of Airbus Helicopters.

• Excluding the disposal gains, PBT would have risen 8.9% y-o-y. Going forward, STE remains positive on engine shop visits, and passenger to freighter conversions (PTF) work. ST Engineering indicated that the ten A330-300 PTF options with DHL are likely to be converted into confirmed orders. 
• The completion of a second composite panel manufacturing plant in Kodersdoft, Germany, in 2Q18 will increase Elbe Flugzeugwerke’s (EFW) capacity for production of floor panels by 50%. EFW owns the exclusive manufacturing rights for floor panels for the Airbus fleet. This is likely to be an earnings driver in the coming years, given the huge backlog of aircraft orders.

Marine division: PBT rebounded to a profit of S$10.1m from a S$8.1m loss in 2Q17.

• This was driven by increased profitability at the ship-repair segment and lower losses from the shipbuilding segment. The shipbuilding segment continues to incur losses despite increased revenue due to insufficient work in the US and overhead costs. 
• Going forward, ST Engineering will be focusing on credit worthy ship-repair work, which will boost profitability.

STE is not directly impacted by tariffs on steel and aluminium in the US in the current quarter.

• ST Engineering indicated that clauses have been built into existing contracts and if necessary, it is able to renegotiate with the counterparties. However, we are unsure if ST Engineering will be able to pass on these costs for subsequent contracts, especially for the commercial segment.

Others division: Higher losses in 2Q18

• Higher losses in 2Q18 due to lower sales from Miltope and interest cost accrued for early redemption of the MTN. However, ST Engineering indicated that sales for Miltope are expected to be recognised in the coming quarters. 
• Interest savings over the next 12 months from the redemption of MTN are also expected to exceed the interest cost of S$15.3m, with net interest savings of S$15m. We believe this segment is likely to turn in profits in the coming quarters.

Operating cash flow declined 24% yoy due to inventory build-up and is not cause for concern.

• Operating cash flow before working-capital changes rose 5% y-o-y.

STOCK IMPACT

Maintain BUY. We are impressed with earnings growth in 2Q18 and expect net profit CAGR of 7.6% in 2018-20.

• ST Engineering also indicated it is actively pursuing Smart City projects and is on track with its prior guidance of Smart City-related revenue doubling to > S$2b in 2022. 
• ST Engineering also managed to secure its first Smart City contract in the Middle East for advanced traffic management and we believe this holds scope for more related contract wins in that region. We are expecting ROIC of 13.5% in 2018, 1ppt higher y-o-y and well above the WACC of 5.8%. Given strong balance sheet and potential earnings growth, we believe investors should stay invested.

EARNINGS REVISION/RISK

• We increase our net profit estimate for 2018 by 2.2% as we factor in higher earnings from JV and associates.

VALUATION/RECOMMENDATION

• Maintain BUY and target price of S$4.10. 
• We continue to value ST Engineering on an EV/Invested capital basis, with long-term ROIC of 14.5%, WACC of 5.8% and long-term growth rate of 2%.

SHARE PRICE CATALYST

• New contract wins.

K Ajith UOB Kay Hian Research | https://research.uobkayhian.com/ 2018-08-10

SGX Stock Analyst Report BUY Maintain BUY 4.100 Same 4.100