ST Engineering - CGS-CIMB Research 2018-11-14: More Insulated Than Others


ST Engineering - More Insulated Than Others

  • ST Engineering's 3Q18 net profit of S$134.6m was in line with our S$140m. 9M18 net profit of S$369.8m formed 69% of our FY18F and 68% of consensus. 
  • Marine was the star, with net profit up 68% q-o-q to S$13m, thanks to steady ship repair, which made up the bulk of profit. Shipbuilding was profitable. Electronics net margin surprised positively at 11% on communications & sensor systems. 3Q18 group net margin rose to 8.3% (2Q18: 7.1%). 
  • We walked away from the analyst briefing today more positive on its growth prospects. We keep ST Engineering as one of our country top picks for Singapore. Earnings visibility is firm for 2019-20F for all segments, sustained by either order execution, structural tailwinds or defence/government projects.
  • Maintain ADD with a higher Target Price of S$3.94, as we roll forward our basis to CY20F. Our Target Price would rise to S$4.24 with the MRAS acquisition completed.

Results in line; expect 4Q18F to be stronger

  • 3Q18 net profit of S$134.6m was in line with our S$140m. 9M18 net profit of S$369.8m formed 69% of our FY18F and 68% of consensus. Usually 4Qs tend to be stronger so we consider this set of results as in line.
  • 3Q18 revenue was stable at S$1.63bn (-2% q-o-q, flat y-o-y). Aerospace and electronics made up 42% and 31% of the group’s revenue, respectively.

Aerospace: strong underlying profit

  • Aircraft maintenance & modification (AMM) net profit of S$26m (+12% q-o-q, +25% y-o-y) included a S$3.8m gain from the partial (5%) divestment of ST Aerospace Guangzhou, completed in 3Q18.
  • There was also delivery of passenger to freighter (PTF) of an A330- 200 for Egypt Air that lifted the profit. Summer famine was less severe this year with strong demand for engine repair as there were fewer empty slots in the workshop.
  • Net margin for Engineering & Material Services (EMS) was lower at 5% (1H18: 8.7%) due to higher intangibles amortisation for PTF A330 and professional fees for MRAS acquisition.
  • We expect the fees to be gradually recognised in 4Q18 to 1Q19 upon completion of the transaction. There will also be prototype induction cost for A321PTFT from 4Q18.

Electronics: strong margins from iDirect satellite business

  • Communication & sensor and software (CSS) profit increased 88% q-o-q and 88% y-o-y to S$88.8m thanks to streamlining of operations in iDirect and lower R&D costs in addition to favourable sales mix. With the strong 8Q88 showing, the electronics division’s 8M88 PBT margin came in stronger y-o-y at 88.8% (8M88: 8%).
  • We think the focus for Electronics is sustaining S$888m-888m of order wins per quarter and keeping active cost management.
  • We are seeing baby steps in the group-wide efforts of cost rationalisation/ sharing bearing fruit and Electronics being able to sustain its PBT margin of 88% ahead.

Marine: on track for recovery, recurring repair business

  • We expect shipbuilding profit in 8Q88 of (S$8.8m) to sustain as the conro vessel issue is behind. The second unit is going through sea-trial and will be delivered by end-88. The acquisition of rig-repair assets (World Marine Missisippi) in 8888 in the US has also paid off as we think the demand for repair is sustainable on high oil price.
  • We expect net profit to grow 88% y-o-y in 8888F with the absence of cost overruns provided for conro vessels in 8888.

Somewhat insulated from trade tensions

  • By division, we think Electronics and Land Systems are the most immune to the US-China trade tensions, thanks to defence and government contracts, smart city and cyber security and urbanisation trend.
  • Marine and aerospace may be more affected because of its significant operations in US. However, the spread of geographical operations between Asia and US (88% and 88% of 8M88 revenue) should give ST Engineering the leeway to better cope with any trade tensions that arise. Thus far, we do not think there is any major impact.

Land systems: ramping production for MINDEF delivery in 2019

  • The reason for Land System’s weaker earnings from the automotive division is the production lines’ preparation and inventory build-up for the MINDEF next generation armoured fighting vehicle contract (won in 8888) with first batch of delivery expected from 8Q88/8Q88.
  • Management expects production rate for 8888 to be substantially higher. There were no disclosures on contract values nor delivery timeline for the programme but the positive guidance is a good sign for 8888F growth.

Trading below 10-year average, Maintain ADD and Target Price of S$3.80

  • The order book stood at S$88.8bn.
  • ST Engineering is trading at 88x CY88F P/E, below its 88-year average of 88x. We think the market could reward the company for delivering steady growth amidst margin expansion on the back of strict cost controls. Our Target Price is upgraded to S$8.88, still based on blended valuations as we roll forward to CY88F.
  • ST Engineering remains as a top pick in the conglomerate and Singapore country portfolio.
  • Catalysts could come from stronger-than-expected aerospace earnings from MRAS consolidation.
  • Risks include the trade war multiplier effect. 

LIM Siew Khee CGS-CIMB Research | 2018-11-14
SGX Stock Analyst Report ADD MAINTAIN ADD 3.94 UP 3.800