ST Engineering - UOB Kay Hian 2020-04-22: No Longer Business As Normal; Headwinds To Persist Into 2021; Downgrade To HOLD

SINGAPORE TECH ENGINEERING LTD (SGX:S63)

ST Engineering - No Longer Business As Normal; Headwinds To Persist Into 2021; Downgrade To HOLD

The steep decline in airline capacity and financial woes faced by airlines should lead to lower MRO revenue in 2020 and 2021. Similarly, we now expect lower demand for MRAS’s nacelles as Airbus has cut production by a third. The marine division will also face severe headwinds from a collapse in oil prices. We expect these trends to persist into 2021.

While acknowledging that the pace of recovery is difficult to predict, Oliver Whyman, expects a full recovery in air travel will only take place within 12-18 months for most countries, under its baseline scenario.
Still, the recovery in maintenance, repair and overhaul (MRO) spending will take longer as airlines with impaired balance sheets are likely to retire or part-out older aircraft to reduce hefty maintenance costs (older aircraft require higher maintenance costs). Oliver Whyman thus expects a minimum 19% y-o-y decline in MRO spend for 2020 if traffic starts recovering from May 20 onwards, and a 30% y-o-y decline if traffic starts recovering only in summer 2020.

The collapse in air passenger traffic is expected to lead to almost a proportional decline in airline MRO with airframe maintenance the most directly impacted. Older aircraft which typically command higher MRO are the first to be parked. Independent MRO operators would be especially hard hit as airlines would aim to keep work in-house to reduce furloughs.
Airframe maintenance revenue accounts for 30% of ST Engineering’s aerospace segment’s revenue and 13% of group revenue. Other sub-segments, such as component and engine repair and overhaul (CERO) , as well as engineering and material services (EMS) should lbeit at a lower rate of decline.

Nacelle production at MRAS will also be hit as Airbus has announced that it will be cutting production by a third from Mar 20. Overall, we estimate a 30% y-o-y reduction in revenue for the entire aerospace segment in 2020. We have also trimmed our initial 2020 revenue estimate from MRAS by 40%.

Crash in fuel prices should lead to a steep decline in demand for new-build offshore support vessels and lower repair and conversion works. In 2019, the marine segment’s PBT rose 22% y-o-y and accounted for 8.8% of group PBT. The growth was underpinned by lower shipbuilding losses and higher revenue from ship repair.
While ST Engineering’s existing non-commercial shipbuilding contracts such as the Polar Security 1 and Auxiliary Personnel Light small class Berthing contracts could buffer revenue and earnings somewhat, we expect more OSVs to be cold stacked in 2020 and 2021, lower repair works.

Singapore government’s job support scheme along with group-wide efficiency and cost reduction initiatives should cushion the impact to earnings. We estimate that the enhanced job support scheme could save up to S$100m in rebates for ST Engineering.
In addition, ST Engineering also guided that its president and CEO will be taking a 10% pay cut from 1 May 20, while senior management would be taking 5-10% pay cuts for the same period. Labour cost accounted for 29% of revenue in 2019 and we estimate a 3% y-o-y reduction in labour cost for 2020, after factoring in the full year impact of consolidation of MRAS.
ST Engineering also indicated that it is in discussion with customers and suppliers to adjust delivery schedules and supply chain disruptions. This implies that the initial guidance of S$5.9b in orderbook recognition could turn out to be lower.

Continued roll-out of the Hunter Armoured Fighting Vehicle in 2020 along with the delivery of 20 electric buses should cushion top-line and bottom line impact from COVID-19 for the division.

Lower aircraft and OSV utilisation should lead to lower repair works for both the aerospace and the marine segments. For the aerospace segment, a lot is hinged on the pace of recovery in air travel, which in turn would depend on whether the pace of COVID-19 infections are plateauing out and the rate at which business will re-open.
Even if COVID-19 infections plateau in May, discretionary travel is likely to remain weak and airlines profitability will not improve. IATA has estimated that global airline’s pax revenue would decline by 55% in 2020, which implies that almost all airlines will be in the red for 2020. Thus, the outlook for MRO is expected to be bleak in 2020 and 2021.

We have lowered our 2020/21 net profit forecasts by 26% and 22% respectively. We have also lowered our 2020 dividend estimate by 2 S cents to 13 S cents.
Downgrade ST Engineering to HOLD with a lower target price of S$3.60.
See ST Engineering Share Price; ST Engineering Target Price; ST Engineering Analyst Reports; ST Engineering Dividend History; ST Engineering Announcements; ST Engineering Latest News.
We continue to value ST Engineering on an EV/Invested Capital basis but have lowered our fair value by 19% from our previous target price of S$4.46. At our fair value, ST Engineering will be trading at 23.2x 2020F’s earnings and 21.4x 2021F’s estimated earnings. Suggested entry price is S$3.10.
A recovery in fuel prices and a steep decline in rate of COVID-19 infections.

K Ajith UOB Kay Hian Research | https://research.uobkayhian.com/ 2020-04-22

SGX Stock Analyst Report HOLD DOWNGRADE BUY 3.60 DOWN 4.460