ST Engineering - CGS-CIMB Research 2019-11-11: Merits Of Diversification

SINGAPORE TECH ENGINEERING LTD (SGX:S63)

ST Engineering - Merits Of Diversification

We would have been spot on in our 3Q19 estimate of S$150m without the one-off S$14m Hornbeck claims. 9M at 70% of our and consensus FY19F.
Key highlights in 3Q19:
1. end of programme review in aero resulted in super profits in CERO and
2. commendable contract wins for aero and electronics.
Our blended Target Price is up to S$4.47. Buy on share price weakness. Catalysts: stronger MRAS and contracts wins; risks: global slowdown. Maintain Add.

ST ENGINEERING (SGX:S63)’s 3Q19 profit of S$139m included S$14.2m of provision for claims for arbitration proceedings with Hornbeck Offshore. See ST Engineering Announcements; ST Engineering Latest News.
The arbitration had been flagged since Feb 2017 with Hornbeck claiming US$48.7m and ST Engineering counter-claiming US$2.4m in a dispute over the design and construction of vessels in 2011. The final provision was announced in Oct as ST Engineering was ordered to pay US$18m. Excluding this, group profit was S$150m (+9% q-o-q and +11% y-o-y), spot on with our expectations but below consensus of S$158m.
Similarly, the marine segment’s net profit would have grown 23% q-o-q to S$17.6m without this, lifted by strong growth in rig and ship repair in the US and shipbuilding in Singapore.

The consolidation of MRAS continued to yield strong profits (c.S$22m in 3Q19, or 33% of aerospace profit of S$65m). Production ramp-up is according to Airbus demand of c.60 units/month. However, we adjust our FY19-21F profit for aero to account for
1. delays in engines from customers which had a ripple effect on certification approvals and
2. delays in the relocation of the pilot training school from Balarat to Jandakot that has plagued Aircraft Maintenance & Modification (AMM) since 1Q19 as well as
3. higher prototype costs for the A321.
Still, we are looking at c.+14% y-o-y profit growth for Aero in FY20F.
Order momentum was impressive at S$1bn in 3Q19, YTD at S$3.1bn (2018: S$2.1bn).

Electronics contract wins also levelled up from c.S$560m/quarter in 2016-18 to c.S$780m/quarter in 2019, with more smart-city related projects. Notably, in 3Q19, it secured S$833m of new contracts with a bulky c.S$300m smart-city related next-generation emergency responses management system for a public safety agency out of Singapore.
YTD wins for electronics totalled S$2.35bn and could hit a record c.S$3bn if the momentum continues. 3Q19 net profit of S$51.5m, +16% q-o-q and -7% y-o-y, was in line with our forecast of S$51.8m. The next key driver for electronics could come from the new satellite communication business (Newtec) consolidation that begins in 4Q19.

We like ST Engineering for its diversification of business. We believe the 15% y-o-y earnings growth could be supported by the execution of its S$15.9bn order book. See ST Engineering Share Price; ST Engineering Target Price.

The amalgamation of two entities in Land Systems (LS) resulted in the reversal of tax credit from prior years and dented LS net profit to S$15.1m (-26% q-o-q, - 14% y-o-y) in 3Q19. Profit was up 10% y-o-y excluding this.
We believe this is part of ST Engineering’s efforts to streamline its operations, which spans across the “others” division, swinging into a S$4m profit in 3Q19 (1H19: S$3.6m losses per quarter). Miltope US has been steady.

We had previously expected aero’s profit to grow by 20% y-o-y in FY20F to S$312m on the back of a full-year consolidation of MRAS. We now expect a 14% y-o-y increase to S$293m. The fundamentals for MRAS are still strong and we believe the ramp-up in production could still hit 60-65 units/month in FY20F. We still expect net profit of c.S$76m from MRAS in FY20F.
Given the development thus far in 9M19 in AMM, we believe it is prudent to factor in longer gestation for passengers to freighters (PTF) conversion of the A321 aircraft as a result of delays in the Supplemental Type Certification (STC) approval.
In addition, product mix for its German subsidiary, EFW, could also be shifted, lowering the workload for composite floorboard panels for certain aircraft. Upside could come from stronger-than-expected MRAS profit contribution.

Even with integration costs, we expect the new sitcom business, Newtec, to be earnings accretive (c.S$10m in FY20F) to ST Engineering. Management guided for a total of S$20m of integration costs. We believe most of the costs will be incurred in FY20F.

We forecast LS’s profit for FY20F to be S$99m (+44% y-o-y) on the back of absence of tax losses and ramp-up in delivery of the Hunter Armoured Fighting Vehicle (AFV) from 1Q20F. The delivery visibility is firm for three years from 2020.
In addition, the progressive delivery of 50 units of three-door double-decker buses to Singapore Land Transport Authority should sustain earnings growth.

On 11 Oct, Marine announced that it had sold its non-core roll-on/roll-off passenger vessel (ROPAX), MV Nova Star to Polish ferry operator, Polferries. The vessel has been on a bareboat charter to Polferries since Sep 2018. There is a gain from disposal of c.S$4m in 4Q19.
We expect marine to grow by 9% y-o-y in FY20F to S$57m, backed by the execution of orders won since 2018. Note that the Polar Ice Breaker contract (S$1bn) will only start to contribute meaningfully from FY21/22F.
We expect more contracts to be announced from existing options, e.g. the Naval Sea Systems Command contract of Auxiliary Personnel Lighter Small APL Class Berthing Barges (S$331m awarded in 2018 including four options to be exercised in 2019-2022).

LIM Siew Khee CGS-CIMB Research | https://www.cgs-cimb.com 2019-11-11

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