ST Engineering - CGS-CIMB Research 2018-09-01: Longer-lasting Engine Upcycle

ST Engineering - CGS-CIMB Research 2018-09-01: Longer-lasting Engine Upcycle SINGAPORE TECH ENGINEERING LTD SGX:S63

ST Engineering - Longer-lasting Engine Upcycle

  • Two points to highlight from the latest US$350m engine contract that ST Engineering’s aerospace division won in this report. See details below.
  • This latest Jet Airways contract is an add-on engine maintenance from US$350m (secured in 2015) to US$700m, now covering the entire 80 B737NGs through 2024. With this, aerospace has secured c.S$1.5bn contracts YTD and could match the FY17 record of S$2.8bn, in our view. We expect the group to secure c.S$5bn in 2018.
  • Maintain ADD on ST Engineering with Target Price of S$3.80, based on blended valuations.

Top up engine MRO contract from US$350m to US$700m

~ ~ Where SG investors share
  • ST Engineering’s aerospace division signed a contract for CFM56-7B engine maintenance, repair and overhaul (MRO) services for the Boeing 737NGs of Jet Airways and its subsidiary, JetLite
  • This is an add-on to an earlier contract signed in 2015 which initially covered only portion of the airline’s 737NG fleet. The latest contract covers the airline’s entire fleet of 80 737NGs, upping the contract value from the initial US$350m (c.S$478m) to c.US$700m (c.S$957m).

Multiple extensions, customers are sticky

  • The relationship with Jet Airways started in 1993 with components MRO, then extended to engine MRO in 2007. A 10-year engine MRO contract worth US$750m was awarded to ST Engineering in 2010 to service Jet Airways’ 143 CFM 56-7B engines. This was extended in 2015 for six years for US$350m. 
  • The current Jet Airway’s contract is the second long-term extension for ST Engineering which testifies to its quality and the fact that airline customers are typically sticky. The current contract entails an integrated suite of engine MRO solutions for six years from 2019.

CFM 56 engines last longer

  • ST Engineering’s aerospace division specialises in the MRO of CFM 56 3/5B/7B engines that power the narrow body A320 and B737 aircraft. These engines are reaching the heavy checks limit, which were expected to come in 2014 but were extended to 2017 due to better reliability. The CFM56 engines can stay on wing for as many as 20,000 cycles, with average time on wing of 18,000 cycles to its first overhaul; or c.9 years without removing the engine for heavy maintenance. 
  • As a reference, in 2004, the expected first shop visit for CFM 56-7B engines was within five years, but was extended to nine years in 2014.

Industry cycle lasts until 2023

  • Based on the delivery schedule of A320 and B737 post Global Financial Crisis in 2009, CFM has delivered c.1,400 of the 56 series engines p.a. This means the engine heavy checks cycle will last until 2023 and peak in 2022, assuming a nine-year heavy check limit. 
  • With the Jet Airways contracts, ST Engineering’s engine cycle will stretch to 2024.

Heavy checks = better margins

  • To recap, the aerospace components/engine repair and overhaul division (CERO) accounted for c.30% (S$27m) of aerospace PBT in 2Q18 (+161% y-o-y). The recovery in engine’s MRO started in 3Q17 with CERO achieving an average of 115% y-o-y PBT growth every quarter. CERO’s PBT margin climbed from a low of c.7% in 2014-16 to c.12% in 2Q18.
  • Heavy checks saw a turnaround of 55-60 days with a price tag of c.S$5m-6m per check while light checks cost c.S$3m-4m per check with a shorter turnaround of several days or a week.

Valuation and Recommendation

  • Maintain ADD and an unchanged Target Price of S$3.80 based on blended valuations.
  • ST Engineering is trading at 19x CY19 P/E, or below its 5-year average of 21x. ROE is defensive at 23-24%, backed by a strong balance sheet. 
  • Surprise defence contracts, consistent quarterly order wins and sizeable earnings-accretive M&A are key catalysts.
  • Key risks to our call are the multiplier effects of a trade war on the global economy.

Lim Siew Khee CGS-CIMB Research | 2018-09-01
SGX Stock Analyst Report ADD Maintain ADD 3.800 Same 3.800