ST Engineering - DBS Research 2019-05-16: Conviction In Growth Story Intact


ST Engineering - Conviction In Growth Story Intact

  • ST Engineering's 1Q19 net profit up 11% to S$131m; on track to solid growth year, with inorganic kicker coming in.
  • Orderbook is at record high of S$14.1bn, on the back of healthy order win momentum across segments.
  • Safe haven stock amid market volatility.
  • Maintain BUY with higher Target Price of S$4.50.

Record high orderbook should drive valuations.

  • With a record S$14.1bn orderbook at the end of 1Q19, SINGAPORE TECH ENGINEERING LTD (ST Engineering, SGX:S63)’s earnings growth potential looks exciting once again after a few tepid years; recent acquisitions in the Aerospace and Electronics divisions puts it on course to achieve close to double digit earnings growth in FY19/20, coupled with dividend yield of more than 4%. See ST Engineering's dividend history.
  • ST Engineering’s 1Q19 earnings was off to a good start as well, with net profit 11% y-o-y higher at S$131.1m.
  • We continue to like ST Engineering for:
    • strong inorganic growth potential from recent acquisitions plus
    • organic growth to be driven by workload increase at Aerospace MRO shops from ongoing issues with new generation aircraft and engines, as well as ramp up of Airbus Passenger-to-Freighter programmes; and
    • medium to long-term growth from leveraging to smart city and IOT related products and contracts, as well as robotics and automation solutions in transport, logistics, healthcare and hospitality domains.

Where We Differ:

  • Demand for ST Engineering’s business divisions should not be affected too much by ongoing trade war tensions, and higher input costs are generally provided for in contracts.
  • Overall, we believe ST Engineering is at the cusp of a ‘next leg up’ in its growth story while trading at reasonable valuations (forward PE of 21x is at +1 S.D. level whereas orderbook is at a record high).

Potential catalyst:

  • Significant order wins, earnings delivery from new acquisitions, and progress with Smart City initiatives.

Key Risks to Our View:

  • Execution hiccups at new business segments and newly acquired entities could derail earnings. Also, higher gearing owing to debt-funded M&A deals could increase finance costs.

WHAT’S NEW ON ST ENGINEERING - Strong start to the year, en-route for robust earnings growth

Net profit in line with expectations.

  • ST Engineering's 1Q19 net profit of S$131m (+11.4% y-o-y, +5.3% q-o-q) was in line with our and consensus’ expectations, driven by solid earnings growth across all business segments except Land Systems division, which saw a marginal decline.

Topline bolstered by growth in aerospace and land systems divisions.

  • Group revenue of S$1,731m was up 5% y-o-y, primarily driven by the Land Systems division, where revenue was up 34% y-o-y likely on the back of armoured vehicle deliveries for the Singapore Armed Forces.
  • Meanwhile, ST Engineering’s Aerospace segment also saw higher revenue (+4% y-o-y), supported by higher engine shop visits and sound momentum in its engineering & materials services.
  • On the other hand, the Electronics segment reported negative revenue growth of 7% y-o-y, owing to a high base (some sizeable projects were recognised in 1Q18), while the Marine segment revenue was flat y-o-y.

Minor PBT margin expansion, in line with our expectations.

  • Overall PBT margin widened slightly to 9.2% in 1Q19, up from 8.7% in 1Q18 and on par with 4Q18. The Marine segment realised a stronger PBT margin, underpinned by higher work volumes and better utilisation of its US shipyards. Similarly, the Electronics division also recorded a modest improvement.
  • Healthier margins in the two above segments tempered slightly narrower margins in the Land Systems and Aerospace divisions, which were affected by a less favourable revenue mix.

Well on track to deliver robust bottom line growth for the following reasons:

Unlike its peer, SIA ENGINEERING (SGX:S59), ST Engineering views the recent grounding of B737 MAX as a slight net positive.

  • Management shared that future utilisation of its hangars should remain elevated, as future capacity, with the exception of the newly established Pensacola facility, has been almost booked out by existing contracts on hand. Moreover, if the B737 MAX were to be grounded for a protracted period of time, airlines may eventually have to reactivate retired older aircraft, which will be subjected to mandatory bridging checks. These older aircraft will also have to go through more regular maintenance checks, which will also benefit MROs.

Inorganic boost from MRAS to materialise in FY19.

  • We estimate that the acquisition of MRAS, which was completed on 18 April 2019, will be a key driver for ST Engineering’s earnings growth in FY19 and FY20. Majority of the transaction costs related to MRAS acquisition was already incurred in FY18.
  • ST Engineering has formed a new dedicated team, comprising of senior staff from the Singapore office and MRAS to ensure the seamless integration of MRAS. The team has made solid progress thus far on ramping up capacity and operational automation.

Newtec to enhance earnings growth in the medium term.

  • ST Engineering’s more recent acquisition of Newtec, in the satellite communications equipment space, is anticipated to be completed in 2H19.
  • We expect slight negative earnings contribution in FY19, as majority of the transaction costs (around 1% of purchase price) and integration costs should be borne in year 1. However, we expect the deal to be incremental to earnings from FY20/21, after the successful integration of Newtec.

Earnings growth is backed by orderbook which is at an all-time high of S$14.1bn as of end-1Q19.

  • As highlighted in our previous report (see ST Engineering - DBS Research: 2019-04-25: Headed For A Bumper Year Of New Order Wins), the group announced substantial new order wins of S$3.1bn YTD in 2019, an impressive amount relative to the estimated S$5.2bn worth of contracts announced in full-year FY18.
  • Additionally, the management shared that they expect to deliver S$4.2bn (30% of orderbook) in the remaining three quarters of FY19, which is a notably higher run rate than highlighted in the previous quarter.

Polar Security Cutter contract with the US Coast Guard should further augment earnings in the longer-term.

  • ST Engineering expects to commence the construction of the first S$1.0bn US Coast Guard Polar Security Cutter in FY21. The first vessel is anticipated to be completed within three years, with the second and third vessels to be delivered in 2025 and 2027 respectively, if the options for them are exercised.
  • Contribution from the first vessel will only begin in FY21, as revenue is recognised based on the percentage of completion method.
  • In the near term, ST Engineering will have to invest in expanding its engineering workforce, and US shipyard capabilities in preparation for construction. However, as per the contract, ST Engineering can begin billing during the 18-month detailed design and planning phase (prior to the start of fabrication), to offset the imminent cash outlays.

Polar contract likely to be earnings accretive, despite the complexity of the project.

  • We view the odds of a cost overrun on the project to be low, as ST Engineering not only went through a comprehensive process to estimate the costs of the project, but also included a decent buffer to arrive at its final bid price.
  • According to management, ST Engineering worked together with design firm Technology Associates Inc, along with leading experts from various countries, and concluded 18 months of design studies prior to the submission of its bid. The approved ship design is based off the Polar Stern ll, the most modern icebreaker on the market, which is currently nearing completion in Germany. During the study, the team incrementally refined the design, and performed multiple design iterations and a series of five ship model tank tests to optimise the design. Hence, ST Engineering has a thorough understanding of each construction stage and its associated costs.
  • Furthermore, ST Engineering has established a team with extensive experience, comprising of inhouse experts, experts from the German shipyard and supply chain partners to support the Polar Security Program. This will strengthen project execution, and also help keep costs in check.

Investment in Singapore’s fibre network.

  • SP Telecom (SPTel), an existing 51:49 JV between ST Engineering and Singapore Power (SP Group), has recently announced that it will be investing “hundreds of millions” of dollars to lay fibre alongside SP Group’s power lines to create a separate and distinct fibre infrastructure from current fibre provided by NETLINK NBN TRUST (SGX:CJLU) under Next Generation Nationwide Broadband Network (NGNBN). See report: Singapore Telecom Sector - DBS Research 2019-04-24: Should NetLink Worry About SP Telecom?
  • SPTel aims to provide alternate fibre connectivity that is complementary to NGNBN and not competing with it, targeting primarily government agencies and major enterprises that require stable and diversified connectivity, in the event of disruptions to NGNBN. Given these plans, we now expect moderately higher capex for the group over the next few years, with contribution from this business to be more pronounced from FY20 and beyond.

ST Engineering is an ideal defensive counter to ride through market volatility:

Relatively insulated against escalating trade tensions.

  • In addition to having considerable business and geographic diversity, ST Engineering’s earnings is underpinned by long-term contracts that often contain adjustment factors, that enable the group to pass on adverse increases in input costs to its customers.

Balance sheet remains resilient, with stable dividend yield.

  • ST Engineering is currently in a modest net debt position of S$197m, with a net gearing ratio of 0.1x. See ST Engineering's share price.
  • Although gearing is anticipated to increase to around 0.4-0.5x after the acquisition of both MRAS and Newtec, we believe ST Engineering still has significant headroom for additional organic and inorganic initiatives, given its stellar AAA credit rating and strong ability to generate free cash flows.
  • Current dividend yield of around 4% should also be attractive to investors. See ST Engineering's dividend history.

Maintain BUY with a higher Target Price of S$14.50.

  • With a record S$14.1bn orderbook at the end of 1Q19, ST Engineering’s earnings growth potential looks exciting once again after a few tepid years; recent acquisitions in the Aerospace and Electronics divisions puts it on course to close to double digit earnings growth potential in FY20, coupled with dividend yield of more than 4%.
  • We revise our Target Price up to S$4.50 as we roll over valuations to blended FY19/20 numbers to fully factor in earnings accretion from recent acquisitions.
  • The Target Price is based on a blended valuation framework, which factors in both earnings growth and the long-term cash-generative nature of ST Engineering’s businesses.

Suvro Sarkar DBS Group Research | Singapore Research Team DBS Research | https://www.dbsvickers.com/ 2019-05-16
SGX Stock Analyst Report BUY MAINTAIN BUY 4.50 UP 4.150