ST Engineering - UOB Kay Hian 2019-05-16: 1Q19 Beats Expectations, Expects Higher Orderbook Recognition For Next 3 Quarters

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SINGAPORE TECH ENGINEERING LTD (SGX:S63)

ST Engineering - 1Q19: Beats Expectations, Expects Higher Orderbook Recognition For Next 3 Quarters

• ST ENGINEERING (SGX:S63)'s 1Q19 net profit growth was better than expected as the marine division recovered and losses from US subsidiary declined. Earnings growth would have been even higher if lease accounting was not implemented.
• ST Engineering also expects higher orderbook recognition for the rest of the year, compared to 1Q19 and thus we expect stronger organic revenue growth for the rest of the year.
• Maintain BUY with an unchanged target price of S$4.70.

ST ENGINEERING 1Q19 RESULTS

Better-than-expected earnings as marine division recovers.

• ST ENGINEERING (SGX:S63)'s 1Q19 net profit rose 11.4% y-o-y, better than our expectation of mid single-digit growth. The earnings growth was mainly driven by:
  1. 38% y-o-y rise in earnings from the marine division, which benefitted from improved US shipbuilding earning,
  2. lower losses from US subsidiary Miltope, and
  3. an 8% y-o-y rise in net profit for the electronic division.
• ST Engineering adopted lease accounting, which led to operating leases being capitalised in the balance sheet. This led to higher D&A and financing cost. 1Q19’s earnings would have risen by a greater quantum were it not for the adoption of the new accounting standard.
• 1Q19 operating cash flow declined by 14.3% y-o-y, but excluding working capital changes, it rose 16.8% y-o-y.

Orderbook recognition for the next three quarters set to rise by 31%.

• As at end-Mar 2019, orderbook grew 6.8% q-o-q to S$14.1b, with the aerospace and electronics sectors contributing S$2.1b for the quarter. ST Engineering had guided that S$4.2b (+ 31% y-o-y) in orderbook is expected to be delivered in next three quaters, which holds scope for stronger organic revenue recognition over the remaining quarters.

Marine division records 77% yoy rise in operating profit and 57% yoy rise in PBT.

• While top-line was flat, improved profitability from the shipbuilding division was a key contributor.

ST Engineering is ramping up to fulfil an order for Polar Security Cutter (PSC) for the US Coast Guard.

• The initial contract was for one PSC worth S$1b, with an option to exercise two more contracts. The option for the contracts will expire in 2023. We believe that the odds of the US Coast Guard exercising the option are high, given heightened competition from other navies. The initial PSC will be delivered in 2024 and if options are exercised, then the delivery for the second and third vessels will be in 2025 and 2027 respectively.
• The contracts have a cumulative value of S$2.6b. ST Engineering highlighted that billing will be on milestone completion and that it expects to recognise revenue starting from 2021.

Airframe maintenance sub-division’s revenue eased by 2.4% yoy in 1Q19, while PBT fell by 24%.

• Higher contribution from the engine division and the materials sub divisions led to flat PBT for the quarter, while net profit rose 5.9% y-o-y due to lower taxes. ST Engineering remains unperturbed, indicating that there is no sign of slowdown in airframe maintenance (MRO).
• ST Engineering also highlighted that revenue recognition from its S$1.3b maintenance contract from a new US airline should kick in from 2020. In addition, ST Engineering indicated that it will be focusing on integrating MRAS and we expect earnings contribution in 2QFY19.

Electronics division revenue declined by 7% y-o-y but STE attributed that to an exceptionally base in 1Q18.

• ST Engineering also expects the acquisition of Newtec to be completed in 2H19.

STE does not expect any material contribution to earnings even if the US Postal Services awards the contract to its partner, Workhorse group.

• This is in contrast to our earlier expectation of a significant uplift to earnings if the latter secures the contract. ST Engineering indicated that the RFP will only be known by 3Q19 and its participation would not be significant.

STOCK IMPACT

Maintain BUY.

• ST Engineering has outperformed the FSSTI ytd, amid a slew of M&As, which provides a concrete framework for ST Engineering’s 5-year plan. We are not too concerned about the slight pullback post results and recommend that investors stay invested.
• ST Engineering’s recent award wins, particularly the S$1b PSC contract along with the S$1.3b aerospace contract, would provide earnings buffer, while recent M&As are expected to be earnings accretive. ST Engineering’s guidance for higher orderbook recognition in the remaining quarters should also reassure investors.

EARNINGS REVISION/RISK

• We have not revised our earnings estimates.

VALUATION/RECOMMENDATION

Maintain BUY with an unchanged target price of S$4.70.

• We continue to value ST Engineering on an EV/Invested Capital basis with a long-term ROIC of 16%, WACC of 6.0% and long-term growth rate of 2.7%. At our fair value, ST Engineering will be trading at 21.7x 2020F PE.

SHARE PRICE CATALYST

• New contract wins for the marine division.

K Ajith UOB Kay Hian Research | https://research.uobkayhian.com/ 2019-05-16

SGX Stock Analyst Report BUY MAINTAIN BUY 4.700 SAME 4.700