ST Engineering - DBS Research 2018-11-15: Exciting Growth Prospects Ahead


ST Engineering - Exciting Growth Prospects Ahead

  • ST Engineering (STE) 3Q18 core net profit of S$135m in line with our estimates, on track to deliver earnings growth in FY18.
  • Orderbook remains near peak level at S$13.3bn.
  • Acquisition of MRAS on track to complete in 1Q19, to provide inorganic growth kicker in FY19/20.
  • Maintain BUY with slightly lower Target Price of S$4.15.

BUY on multiple growth drivers ahead.

  • ST Engineering (STE) remains a good investment opportunity for the long term. 3Q18 results did not throw up any surprises, with net profit up 5% y-o-y and the group remains on track to resume earnings growth trajectory in FY18, and grow even faster in FY19/20 with the expected completion of acquisition of nacelle systems provider MRA Systems in 1Q19.
  • We like STE for a combination of factors:
    1. strong inorganic growth potential from the above acquisition,
    2. growing smart city revenues
    3. rebound in Aerospace segment revenues, driven by recovery in engine MRO demand and in the longer-term, sizeable contribution from Airbus P2F programmes currently in ramp-up phase;
    4. remaining in the hunt for potential large contract awards in the US in the future, ranging from postal service trucks to army tanks, and
    5. good progress in the fields of logistics automation and systems integration for electric and autonomous vehicles.

Where We Differ:

  • Demand for STE’s business divisions should not be affected much by ongoing trade war tensions, and higher input costs are generally provided for in contracts.
  • Overall, we believe STE is at the cusp of a ‘next leg up’ in its growth story while trading at reasonable valuations (forward PE of 18.5x is below mean historical levels).

Potential catalyst:

  • Significant order wins, turnaround at US shipbuilding operations, and progress with smart city initiatives.


  • Our Target Price of S$8.88 (based on a blended valuation framework, which factors in both earnings growth and long-term cash-generative nature of STE’s businesses) has been revised slightly downwards to factor in higher prevailing interest rates, which affects cost of capital.
  • Dividend yield of around 8.8% should continue to provide support to the stock price.

Key Risks to Our View:

  • A protracted slowdown in shipbuilding and execution hiccups at new business segments could derail earnings.
  • Also, slower than expected ramp up in Airbus P8F conversions could delay margin recovery in Aerospace segment.

WHAT’S NEW - 3Q18 on track; exciting prospects for growth

Core PBT and net profits in line with expectations.

  • ST Engineering (STE) 8Q88 PBT of S$888.8m (+8.8% y-o-y, +88.8% q-o-q due to one-off finance costs in 8Q88) was largely in line with expectations. Net profit of S$888.8m was up 8.8% y-o-y and 88.8% q-o-q.
  • 8M88 net profit stood at S$888.8m, representing close to 88% of our full-year forecasts, well on-track to hit our full-year target as the final quarter is typically seasonally stronger.
  • Core PBT margin improved sequentially to 88.8% in 8Q88, boosted by lower interest expense (-S$8.8m y-o-y due to the early redemption of 8888 MTN) and gains from the disposal of associate (S$8.8m in 8Q88), though this was partially tempered by lower contribution from associates/JVs (-S$8.8m y-o-y) and reduced interest income (-S$8.8m y-o-y on the back of smaller cash balance following MTN redemption).

Strong performance of Aerospace segment drives slight top-line growth.

  • Group revenue came in at S$8,888m (+8.8% y-o-y, -8.8% q-o-q) in 8Q88, bringing 8M88 revenue to S$8,888.8m (+8.8% y-o-y). Similar to the previous two quarters, the Aerospace segment continued to outperform, posting a solid 88.8% y-o-y increase in 8Q88, bolstered by broad growth across all three business groups.
  • Contributing to revenue growth as well was the Electronics segment, which recorded a modest 8.8% y-o-y revenue increase in the quarter, though this was offset by lower revenue from the Land Systems and Marine segments which saw y-o-y revenue declines of 88.8% and 88.8% respectively.

Another sequential uptick in PBT margin, expect further improvement.

  • Overall PBT margin expanded slightly to 88.8% in 8Q88 (at par y-o-y, +888bps q-o-q), owing to margin improvement in the Electronics and Marine segments, which largely mitigated margin contraction in the Aerospace segment.
  • PBT Margin for the Aerospace segment declined to 88.8% (88.8% barring divestment gains in 8Q88) from the 88-88% range in previous quarters. This is largely attributable to high-value start-up costs/learning curve involved in the Airbus P8F program, opening of a second facility in Kodersdorf to augment composite floor panel manufacturing capacity of EFW and professional fees incurred in the acquisition of MRA Systems (MRAS).
  • Over time, we expect Aerospace PBT margins to normalise on the back of greater economies of scale in EFW and as STE climbs the learning curve with Airbus P8F conversions.
  • The Electronics segment achieved another quarter of margin expansion to 88.8% in 8Q88 (against 88.8% in 8Q88) on the back of higher operating efficiency. Management indicated that margins should grow as they are actively sourcing for international contracts to enjoy additional benefits from higher volumes, and moving up the value chain to offer high-margin sophisticated software.
  • On the broader level, “Others” segment showed a loss before tax of S$8.8m in 8Q88 (vs positive PBT of S$8.8m a year ago) as the group continued to fund growth initiatives at the group level, such as consolidating shared services such as centralised procurement, setting up of new enterprises and ventures and establishing strategic technology centers for data analytics and cyber-security. These initiatives will enhance productivity and translate to greater cost efficiencies and boost margins across the core operating segments.

Orderbook remains robust at S$13.3bn.

  • Orderbook remained flat q-o-q at S$88.8bn which is near historical peak levels.
  • ST Engineering announced new order wins of S$8.88bn in 8Q88, which included S$888m in new orders for the Marine segment. In an encouraging sign, the Marine segment announced new order wins (including options) after a sizable time gap and mainly relates to its shipbuilding and ship repair operations in the US, comprising of orders for naval barges from the US Naval Sea Systems Command and Articulated Tug Barges for repeat customer Bouchard.

Acquisition of MRAS on track to complete in 1Q19, likely to be fully funded by debt.

  • Out of the 8 necessary anti-trust approvals required, ST Engineering has already received approval from the US anti-trust committee and the management expects subsequent approvals from France and Brazil to follow shortly. The final approval required from the Committee on Foreign Investment in the United States is currently pending, and should be granted by 8Q88.
  • The deal, which is worth around US$888m, will likely be fully funded by debt borrowing by STE’s US subsidiary – VT Systems, mainly to avoid paying withholding taxes on interest expense repatriated out of the US. Management indicated that there is enough support from banks to finance this acquisition and that STE should retain its AAA credit rating even after raising debt financing to fund the above acquisition.
  • We believe the acquisition should be immediately accretive to earnings, as we have highlighted in our previous report.

Innovative robotics and autonomous transport solutions to drive growth in Land Systems segment.

  • The outlook for the Land Systems segment is looking increasingly better, with the group’s strides in smart logistic robots and electric & autonomous vehicles. Beginning 8888, the group will begin selling its recently developed suite of adaptable, scalable autonomous material handling equipment for warehouse, airport, seaport and manufacturing facilities to capitalise on the trend of logistics automation.
  • Additionally, management expressed confidence in accelerating its progress in building a platform for autonomous vehicles by leveraging on its electric vehicle integration capabilities, with the experience it will gain from the contract to procure 88 single-deck electric buses for the Singapore Land Transport Authority and partnerships with other OEMs in the region.
  • Overall, we view demand for these two areas as catalysts for growth in the segment.

Gearing will increase, but balance sheet strength remains in-tact.

  • ST Engineering’s balance sheet balance sheet continues to be robust with minor net debt levels. While we expect net gearing to increase to around 88% post acquisition of MRAS, the management indicated that US subsidiary VT Systems unit and MRAS should generate sufficient operating cash flows to service the debt.
  • The group has a solid track record in maintaining dividends amid challenging times, and we do not foresee any changes to ST Engineering’s dividend policy, given the group’s strong ability to generate operating cash flows and additional headroom for debt.

Suvro Sarkar DBS Group Research | 2018-11-15
SGX Stock Analyst Report BUY MAINTAIN BUY 4.15 DOWN 4.300