ST Engineering - CGS-CIMB Research 2019-05-15: Quality Refuge


ST Engineering - Quality Refuge

  • We think there are still catalysts for ST Engineering share price which includes
    1. capacity expansion in MRAS and
    2. stronger contribution from contracts won.
  • ST Engineering (SGX:S63) is a quality name for shelter in an uncertain environment with its earnings predictability and decent c.4% yield. Maintain ADD.
  • We lift Target Price to S$4.43, now based on a higher P/E of 22x FY20F in our blended valuations. Our Target Price implies forward P/E of 21x, or +0.5 s.d. of its 5-year mean.

Results in line, forming 22% of FY19F, S$3.1bn order win YTD

  • ST Engineering’s 1Q19 net profit of S$131m (+11% y-o-y, +5% q-o-q) was in line with our S$129m expectations, forming 22% of our FY19F and consensus.
  • Order book stood at S$14.1bn, taking in S$2.1bn of orders in 1Q19. Including the S$1bn marine US Coast Guard Polar Security Cutter contract, order book would be S$15.1bn. YTD order has been impressive at S$3.1bn, surprising its peers in the capital goods sector.

FY19 to break historical lacklustre -3% p.a. earnings growth

  • ST Engineering share price has gradually performed in the past three months thanks to sizeable order wins announced YTD. We think there is still room for upside in the next 12 months as ST Engineering carefully executes contracts won in the past two years.
  • Acquisition-led growth from MRAS in 2019 and Newtech in 2020 will help to break ST Engineering’s past 5 years’ lacklustre -3% growth. We forecast 22% and 11% y-o-y growth for FY19F-20F. So, we lift our Target Price on FY19 P/E of 22x (previously 21x) in our blended valuations.

How is marine doing it differently in the S$1bn contract

  • With some patchy cost overrun track record for Conro projects done by the US yard, management has taken more vigorous steps and diligent tests, working closely with the US Coast Guard to ensure the feasibility of the recently won contract. Design studies began in 2017. This will be followed by another 18 months of detailed planning before construction begins in 2021.
  • US Coast Guard will ensure ST Engineering’s US yard is production ready before steel cutting. Risk of cost overruns appears low given it is a defence contract with stringent requirements. There are also plans to increase engineering headcount in the US yard. Current workforce stands at 500 people.

MRAS to start contribution in 2Q19

  • MRAS will start to contribute to Aerospace and be earnings-accretive by 2Q19. Current nacelle production has expanded to 60 units per month (from 50 per month in 2018), representing 10% y-o-y increase. Management expects expansion to be on track and could reach +15% in 2019.
  • We forecast S$26m/S$86m profit contribution from MRAS in FY19F/FY20F, resulting in 12% and 26% y-o-y earnings growth.

Potential 3% earnings upside to STE from land systems in FY20F

  • The successful delivery of NGAFV for the Singapore Army in 3Q19 may swing automotive division’s profit from S$1m to c.S$10m-12m/qtr. LS FY20F profit may grow by 30% y-o-y to S$99m vs. our current S$80m (+7% y-o-y) target, adding 3% to group’s profit.

More details on segments

Aerospace could benefit from B787-MAX grounding

6% y-o-y net profit growth.

  • Aerospace profit of S$62.7m (+6% y-o-y, -1% q-o-q) is in line with expectations. Airframe maintenance and modification (AMM) profit dropped 23% y-o-y and 46% q-o-q to S$21.5m due to delay in pilot training centres relocation. This could last into 2Q19 but we think seasonal effect of stronger 2H could still take place.
  • Component, Engines. Repairs & Overhaul (CERO) profit grew 25% y-o-y and 73% q-o-q to S$19m thanks to the recovery of interest income charged to a client.
  • EMS (Engineering and Material Service) profit was up 40% y-o-y and 75% q-o-q to S$22.2m. Other than tax benefit adjustments, we believe EFW’s panel delivery to Airbus remained strong.

B787-Max grounding a slight positive.

  • If the grounding of B787-MAX prolongs beyond 3Q19, management believes there will be more slight positive impact on the after-market as airlines are likely to invest in older generation aircraft to backfill the capacity loss due to the grounding. However, this could also result in a worse-off summer famine in 3Q19 with lesser checks as more aircraft are in the air.
  • Beyond that, parked aircraft could be reactivated for bridging check. Retirement of older aircraft could also slow.

Labour shortage is key concern, trade war has limited impact on cost.

  • The shortage of qualified engineers is an ongoing concern across countries. We believe rising staff costs could be an upcoming trend especially in the US.
  • On the flipside, trade tariff has limited near-term impact on the equipment costs as most of the parts are either US or European made.

Electronics to maintain momentum

Large-scale group back to normal.

  • Electronics profit of S$43.4m (+8% y-o-y, - 2% q-o-q) is lifted by sales mix. Large Scale Systems Group (LSG) profit grew from S$1.7m in 4Q18 to S$17.5m in 1Q19 as a result of corporate cost allocation in 4Q18. The satellite business in the US, I-direct was seasonally weaker in 1H19.
  • We believe electronics is able to hit its target PBT margin of 10% for FY19F based on execution of contracts won worth c.S$2.3bn p.a. since 2016. The S$818m orders won in 1Q19 are considered as unusually strong and we expect c.S$500m/quarter to be more sustainable.
  • Newtech transaction cost of 1% (c.$4m) will be booked in 2H19 under Communication and sensor systems group (CSG). This could swing profitability in 2H19F.

Marine: all is well in the US, hopefully

Shipbuilding net margin steady at 3%.

  • Marine posted the highest growth in profit to S$12m (+38% y-o-y, -12% q-o-q), slightly below our S$13.7m expectations mainly due to lower-than-expected ship repair profit. Shipbuilding was profitable with a steady q-o-q net margin of 3% with better performance from the US. US contributed to 25% of its revenue.
  • Ship repair revenue grew 32% y-o-y and 34% q-o-q to S$75m. Accordingly, more costs were allocated to the division, which resulted in dip in margin to 12% vs. the typical high-teens and 20% level.

Land systems: lower operating costs from 2H19

Service trading made up the whole of 1Q19 profit.

  • Land systems (LS) profit was the weakest in the group in 1Q19 at SS$15.2m (-3% y-o-y) but this is not a surprise. This is due to upfront investment costs set up to prepare for the New Generation Armoured Fighter Vehicle (NGAFV). However investments in robotics capabilities will likely remain consistent in the near term.

Profit could go up by 30% y-o-y in FY20F.

  • The successful delivery of NGAFV for the Singapore Army from 3Q19 could swing automotive division’s profit from S$1m to c. S$10m-12m/qtr.
  • Land systems’ FY20F profit could grow by 30% y-o-y to S$99m vs. our current S$80m (+7% y-o-y) target, adding 3% to group’s profit.

Valuations & recommendation

  • We think ST Engineering could trade up to +0.5 sd of its 5-year mean if it is able to deliver double-digit earnings growth from FY19F.
  • Our Target Price is still based on blended valuations, on 22x P/E FY20F (previously 21x), 4% yield on FY19F DPS and DCF (WACC: 6.9%, LTG:3%).
  • Key risk to our call is ripple effects from trade war on global economy.

LIM Siew Khee CGS-CIMB Research | 2019-05-15
SGX Stock Analyst Report ADD MAINTAIN ADD 4.43 UP 4.080