ST Engineering - DBS Research 2020-02-25: Strong Immunity Against COVID-19


ST Engineering - Strong Immunity Against COVID-19

  • 4Q19 net profit exceeded expectations, ST Engineering exits FY19 with double digit growth in earnings.
  • Final DPS of 10Scts in line, full year DPS at 15Scts.
  • Modest earnings impact from COVID-19; trimming FY20F net profit by 2.8%.
  • Maintain BUY with marginally lower Target Price of S$4.60.

Solid earnings beat; limited COVID-19 impact

  • ST Engineering (SGX:S63)'s 4Q19 net profit beat consensus’ and our expectations, coming in at S$169.5m (+36% y-o-y, +22% q-o-q), with full-year net profit of S$577.9m representing 102% of consensus’ full year estimate. Growth in 4Q19 was largely driven by inorganic growth in the aerospace division led by the acquisition of MRAS, favourable tax adjustments (effective tax rate of 12% in 4Q19 vs 17% in 4Q18) and the absence of a c.S$15m impairment and divestment loss in the land systems division.
  • Record high 29% y-o-y top line growth in 4Q19 underpinned by robust growth in aerospace (S$941m, +45% y-o-y) and electronics (S$693m, +27% y-o-y) divisions. The land systems and marine segments saw healthy revenue growth as well, at +3% and +47% y-o-y to S$456m and S$204m respectively.

Broadly stable margins in line with expectations.

  • ST Engineering's 4Q19 overall PBT margin stood at 8.7% (vs 4Q18: 9.0%, 3Q19: 8.1%), primarily owing to thinner margins in the aerospace and electronics division. PBT margin in the aerospace division narrowed to 10.1% during the quarter (vs 12.8% in 4Q18), largely due to integration and start-up costs incurred at MRAS, costs associated with mounting the learning curve for new variants in its P2F programme, and staff costs pressures in its North American operations.
  • Meanwhile, its electronics division also saw slimmer margins due to transaction and integration costs associated with newly acquired iDirect Europe (formerly known as Newtec) and Glowlink, and continued investments in growth areas. Conversely, PBT margins improved in the marine and land systems segments to 12.8% and 6.3% respectively.

Final dividend of 10Scts/share declared; management reaffirmed commitment to reward shareholders.

  • This brings full-year dividend to 15Scts/share, flat y-o-y and in line with our expectations, representing 80% dividend payout ratio (down from 95% in FY18, and average of 92% in FY14-18).
  • Management indicated that dividends should grow in line with profits, which leads us to maintain our FY20 total dividend forecast of 16Scts/share, which implies a yield of 3.8% at current prices.

Gearing goes up, but capacity for more debt-funded acquisitions remains.

  • Net debt rose to S$1.9bn in 4Q19 (4Q18: S$0.1bn, 3Q19: S$1.7bn), with its net debt to EBITDA and net gearing metrics increasing to 1.8x and 0.8x respectively. Nevertheless, ST Engineering still has considerable headroom to stimulate inorganic growth – ST Engineering’s current cost of debt is around 3.0-3.5%, thanks to its stellar AAA credit rating.
  • Though the majority of ST Engineering’s debt is now short-term debt, terming out its debt maturity with more long-term paper should be no problem, given its solid track record in the capital markets and sound working relationship with banks.

Outlook on 2020

COVID-19 impact expected to be limited; trimming FY20F net profit by 2.8%, FY21 projection remains intact.

  • We believe ST Engineering’s earnings will remain resilient against COVID-19 due to the following reasons:
    1. The company is a diversified conglomerate, with its operations spanning across multiple businesses and geographic locations. But of course, we expect the Aerospace division’s heavy maintenance (airframe maintenance and modification) revenue to be impacted to an extent as ongoing air travel restrictions mean fewer flying hours and less maintenance requirements. Airlines facing prospect of weaker numbers may also defer maintenance spending by as long as possible. At the time of SARS, the air travel industry had taken about 9 months to recover to pre-crisis levels, so we can expect slightly weaker numbers from the Aerospace division over the next few quarters. However, the impact is not likely to be very significant, as even during the last global financial crisis, ST Engineering’s Aerospace division saw a revenue decline of less than 4% in FY09 and an earnings impact of around 15%. Overall, ST Engineering recorded only 6% earnings decline in FY09, demonstrating the resilient nature of its diversified business portfolio.
    2. ST Engineering’s orderbook is near its all-time high at S$15.3bn, up from S$13.2bn a year ago, due to robust contract wins of S$8.0bn in 2019, up 53% from 2018. ST Engineering expects to deliver S$5.9bn in 2020 (39% of orderbook), a slightly higher run rate compared to 2019.
    3. ST Engineering’s Aerospace division has only a small presence in China, via a wholly-owned Xiamen engine workshop, a 49% owned associate, Shanghai Technologies Aerospace Company (share of profits in FY18: S$6.5m), and a 44% owned associate, ST Aerospace (Guangzhou) Aviation Services Co Ltd (share of profits in FY18: S$3.3m).
    4. Electronics segment has modest exposure to China. Though we do expect some delays in project execution in ST Engineering’s China mass rapid transit and rail electronics projects, contribution from these projects do not constitute a meaningful proportion of profits.

Medium-term growth trajectory continues to be encouraging.

  • Despite the near-term headwinds, we believe ST Engineering’s medium-long term growth prospects continue to be sound, underpinned by:
    • Earnings growth in the aerospace division should remain buoyant as ST Engineering makes progress in its passenger-to-freight (P2F) programme (with more A330 P2F deliveries; ST Engineering expects to obtain a Supplemental Type Certificate for the A321 P2F in 1Q2020), and successful securitisation of thirty engines frees up considerable capital at 50% owned JV – Total Engine Asset Management (TEAM). Using a securitisation structure also enables ST Engineering to expand its engine leasing pool with minimal capital and realise greater MRO synergies with more engine lessees.
    • Its electronics division will receive an inorganic boost from the acquisitions of Newtec and Glowlink. Smart city revenue in FY19 was S$1.4bn, up 40% from 2017, and the management reiterated their confidence in meeting their target of S$2.0bn revenue by 2022. Furthermore, ST Engineering’s cybersecurity revenue should be supported by the Government’s push (S$1.0bn over the next three years) to augment its cyber and data security capabilities.
    • Land systems should see greater demand for its autonomous logistics solutions, which is applicable in warehouses, airports, seaports and factories. Meanwhile, ST Engineering will continue to scale up production of the Hunter Armored Fighting Vehicle (AFV) for the Singapore Army and accelerate deliveries over the next few years.

Potential near-term catalyst – provision of nacelle solutions for the re-engining of United State Air Force (USAF) B52 bombers.

  • The USAF is planning a massive re-engining program for its long-range strategic bomber. New engines need new nacelles (engine housing) and tentative estimates place the program size at 650 nacelles, with the price of each nacelle at around US$7m, meaning that the entire nacelle contract would thus be worth around US$4.5bn (S$6.3bn). ST Engineering’s newly acquired subsidiary MRAS is currently manufacturing nacelles for two out of the four engine variants in the race (GE Aviation’s CF34-10A and Passport) for the B-52 but can easily reconfigure its layout to offer solutions for the other two variants (Pratts & Whitney’s PW800 and Rolls Royce’s BR725) as well.
  • We believe that MRAS, with its advanced manufacturing capabilities and end-to-end program expertise places it in good position to win some nacelle orders from the engine supplier. The USAF is currently targeting Request for Proposal (RFP) by 1Q2020; however, this has been delayed on multiple occasions, and hence the timeline remains murky.

Maintain BUY with slightly lower of S$4.60.

Suvro Sarkar DBS Group Research | Jason SUM DBS Research | https://www.dbsvickers.com/ 2020-02-25
SGX Stock Analyst Report BUY MAINTAIN BUY 4.60 DOWN 4.640