ST Engineering - UOB Kay Hian 2018-10-01: M&A Raises Value Proposition For Shareholders; Expecting 1.3 SCents EPS Accretion For 2019

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SINGAPORE TECH ENGINEERING LTD SGX:S63

ST Engineering - M&A Raises Value Proposition For Shareholders; Expecting 1.3 S Cents EPS Accretion For 2019

• We raise our fair value for ST Engineering to S$4.06 from S$3.80, the difference being the impact of incremental earnings contribution in 2019.
• Given the huge backlog on the Airbus A320 Neo aircraft, we are now more confident that it will more than offset the decline in production of the more mature nacelles.
• We also raise our 2019 dividend estimate by 1 S cent to 17 S cents and this provides a forward yield of 4.8%. We deem this attractive for an AAA-rated firm.
• Maintain BUY. Target: S$4.06.

WHAT'S NEW

Raising our 2019 and 2020 EPS estimates by 1.25 S cents and 1.72 S cents respectively, following the acquisition of MRAS.

• We estimate that Middle River Aircraft Systems’ (MRAS) revenue will rise by 10% in 2019 from the 12 months ending Jun 18. Assuming that the acquisition is completed by 1Q19, we estimate that MRAS 2019 net profit contribution could approximate S$39m or a 6.7% increase over our prior estimate.
• For 2020, the implied net profit growth, post acquisition, is estimated at 8.6%. We have also assumed 75% debt funding at a 3.9% interest cost. Even with new debt funding, gross gearing is estimated at 33% in 2019 vs 45% in 2017, due to an early redemption of US$500m in medium-term notes in Jul 18.
• We have also estimated that ST Engineering will amortise intangible assets (primarily IPs relating to the nacelles) of S$380m over a 20-year period.

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Leap 1A engine nacelle production expected to offset the production of mature nacelles.

• MRAS' revenue consists of engine nacelle production and their thrust reversers, complex aero-structures for commercial and military aircraft as well as sales of spares and maintenance and repair and overhaul. We estimate that nacelle production could account for at least 50% of revenue.

Production of leap 1A engines and nacelles are estimated to accelerate in 2019, as Airbus has a backlog of 6,040 orders on the A320 Neo

• Airbus has guided that aircraft production in 2019 will rise towards 63/month by mid-19, vs an average of 55 per month as at Aug 18. Given that 60% of those who decided between the two engine options have chosen the Leap 1A, MRAS' production rate should theoretically rise at a faster rate than Airbus' (ST Engineering had earlier guided that MRAS' nacelle production for the Leap 1A, could rise 40-50% in 2019).
• The incremental nacelle production for Leap 1A should also more than compensate for the loss of mature nacelle production. Based on that, we have conservatively estimated 10% y-o-y growth in top-line for MRAS in 2019.

Dividend payout will not be impacted.

• We have assumed that ST Engineering will fund the S$606m acquisition, via 75% debt. Even if ST Engineering opts for a lower 50% debt, we believe the company will still be able to fund 2018's final dividend and 2019's interim dividend via operating cash flow.
• For 2019, we now expect ST Engineering to pay out 17 S cents on 85% payout.

STOCK IMPACT

Enhancing shareholder return; BUY ST Engineering.

• We are now more confident that the acquisition of MRAS will add value to shareholders. The backlog for the next-gen engines are substantially higher than that for mature engines and will provide a stable revenue platform for the next 10-years.
• ST Engineering could also gain further synergy by providing a one-stop maintenance solution for the Leap 1A nacelle and engine via MRAS. For now, we believe that our estimate of 10.6% EBITDA margin for MRAS in 2019 poses little downside risk.

EARNINGS REVISION/RISK

• We raise our 2019/20 net profit estimates by 6.7% and 9% respectively on the back of the M&A.

VALUATION/RECOMMENDATION

Maintain BUY with a higher target price of S$4.06.

• Our previous fair value of S$3.80 was based on EV/Invested capital and implied a 20.9x PE on 2018's EPS. We now add S$0.26 to our fair value, with it being 20.9x the incremental 2019 EPS to our target price.
• At S$4.06, ST Engineering will be trading at 20.5x 2019's earnings and should offer a dividend yield of 4.2%. We believe the stock is undervalued, with 2019F's PE and dividend yield amounting to just 17.9x and 4.8% respectively.

SHARE PRICE CATALYST

• Already in place.

K Ajith UOB Kay Hian Research | https://research.uobkayhian.com/ 2018-10-01

SGX Stock Analyst Report BUY Maintain BUY 4.06 Up 3.800