ST Engineering - UOB Kay Hian 2018-09-14: Acquisition Will Provide STE With A Critical Path To The Aircraft Manufacturing Supply Chain

SINGAPORE TECH ENGINEERING LTD (SGX:S63) | SGinvestors.io SINGAPORE TECH ENGINEERING LTD SGX:S63

ST Engineering - Acquisition Will Provide STE With A Critical Path To The Aircraft Manufacturing Supply Chain

  • ST Engineering plans to acquire MRAS, an OEM manufacturer of aircraft nacelles. MRAS is one of five large nacelle companies globally and is the single source nacelle provider for the Leap 1A engine, which will be used on the A320 Neo.
  • The acquisition price of 10x EV/EBITDA and 14-15x estimated 2018 PE is highly attractive. From a strategic perspective, this will transform the aerospace division into an OEM and one which will be able to realise synergies via after-market services.
  • Maintain BUY. Target: S$3.80.



WHAT'S NEW


ST Engineering (STE) proposes to acquire a 100% stake in nacelle manufacturer MRAS from General Electric (GE) for US$630m.

  • A nacelle is an exterior casing for engines and costs between US$1.2m-1.6m each. Middle River Aircraft System (MRAS) owns 17 patents and operates out of the US.) collaborates with Safran Nacelles, to manufacture Leap 1A engine nacelles.
  • Out of the 6100 A320 family Neo orders, 38% will be powered by the Leap 1A engine and another 35% remain undecided between the Pratt & Whitney GTF Engine and the CFM Leap 1A engine. Only 437 of such orders have been delivered as at August 2018.



~ SGinvestors.io ~ Where SG investors share

Biggest acquisition to date.

  • The acquisition will be subject to regulatory approval from the US, France, and Brazil, and is expected to be completed by 1Q19. The base purchase amounts to US$630m (S$868m), on a cash-free and debt-free basis. The net purchase consideration is estimated at US$440m, after factoring in unfunded pension obligations.
  • ST Engineering will fund the acquisition via a mix of debt and equity. As at end-1H18, STE had S$1.2b in liquid funds, with S$148m in net cash. MRAS' audited PBT before minority interest for 1H18 amounted to US$24m (S$33.2m).
  • ST Engineering did not disclose the acquisition PE, but we estimate annualised PE of 14-15x. ~SGinvestors.io ~ Where SG investors share

Moving further up the value chain.

  • ST Engineering believes that with the acquisition, the aerospace division will be moving up the value chain from being a large maintenance provider, to a manufacturer. We concur with this view.
  • ST Engineering had in 2016 acquired a 55% stake airbus panel manufacturer, EFW and acquired the intellectual property for A320 and A330 passenger to freighter conversion. The move to acquire MRAS will move ST Engineering up the manufacturing value chain into advanced composite manufacturing and is also synergistic to its existing maintenance and repair (MRO) business, as it would then be well placed to provide maintenance on nacelles.
  • Nacelle MRO is expected to account for US$2.4b by 2025. ~SGinvestors.io ~ Where SG investors share


STOCK IMPACT


A good diversification move and a step up the value chain.

  • MRAS will be able to provide nacelles to China's Comac C919 and ARJ 21 aircraft, both of which have garnered 1,200 orders. STE also guided that the ramp-up phase will see a 40-50% increase in nacelle production in 2019, which could imply that forward PE multiples are likely to closer to 20x. ~SGinvestors.io ~ Where SG investors share
  • With trailing EV/EBITDA multiple amounting to 10x, this implies that the unit generates operating cash flow of about US$63m, which could rise towards US$100m in 2019, after factoring in positive operating leverage. Excluding minority interest, that could amount to 12% of our estimated operating cash flow before working capital changes for 2019.


EARNINGS REVISION/RISK

  • We have not revised our earnings estimate for 2019 as the impact to earnings will depend on the funding mix and upon regulatory approval. We estimate that that ST Engineering will take on 50% debt to fund the acquisition.


VALUATION/RECOMMENDATION

  • Maintain BUY with an unchanged target price of S$3.80. We continue to value ST Engineering on an EV/invested capital basis with long-term ROIC of 14.4% and terminal growth rate.


SHARE PRICE CATALYST

  • New contract wins and regulatory approval for the M&A.





K Ajith UOB Kay Hian Research | https://research.uobkayhian.com/ 2018-09-14
SGX Stock Analyst Report BUY Maintain BUY 3.800 Same 3.800



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