ST Engineering - DBS Research 2020-08-17: Recovery Story Not Imminent


ST Engineering - Recovery Story Not Imminent

  • ST Engineering's 1H20 headline net profit slightly better than expected, with significant government financial support, but core margins weak.
  • Government grants to continue in 2H20, cushioning the impact of COVID-19; FY21F will remain challenging.
  • Interim DPS of 5.0Scts declared.

1H20 results review – operational challenges masked by government grants

  • ST Engineering (SGX:S63)'s 1H20 net profit of S$257.4m (-4.4% y-o-y, -17.2% h-o-h) topped street’s expectations, forming 53.0%/50.0% of consensus/DBS full-year estimates respectively.
  • Management indicated that ST Engineering received slightly less than S$150m financial support from various governments around the world in 1H20, driven largely by the enhanced Singapore Jobs Supports Scheme for the local aerospace MRO sector. This helped partly offset the impact of COVID-19 on its overall business, as well as losses from impairments (primarily in the aerospace and electronics sector) amounting to around S$24m in 1H20.
  • ST Engineering's 1H2020 group revenue was fairly stable, at S$3.57bn (up 1.7% y-o-y, down 18.0% h-o-h), largely driven by inorganic growth during the period – ST Engineering enjoyed six full months of contribution from MRAS (vs two and a half months in 1H19) and Newtec (acquisition completed in 2H19). Excluding the acquisitions, ST Engineering’s revenue during the period would have been down c.7.0% y-o-y, dragged by weakness in its components and engine repair and overhaul, and communications and sensor systems group segments.

Group PBT margin declined to 8.0% in 1H20, down from 9.4% in 1H19 and 8.4% in 2H19.

  • Barring the impact of government financial support and one-off impairments during the period, ST Engineering would have achieved PBT of around S$160m, with a PBT margin of 4.4%.
  • Division-wise, all but the Land Systems division saw margin compression, with the aerospace and marine segments experiencing the steepest declines, owing to COVID-19 induced project delays, supply chain/work force disruptions and cost overruns in shipbuilding projects in the Marine division.

Order backlog down slightly to S$15.9bn as at June-2020

  • Order backlog down slightly to S$15.9bn as at June-2020, from the peak of S$16.3bn in March-2020, with an implied book-to-bill ratio of 2.0x. Despite the challenging operating environment, the group managed to secure new aerospace and electronics order wins of S$1.1bn in 2Q20, bringing total announced contract wins in 1H20 to S$2.7bn (-25.0% y-o-y).
  • ST Engineering expects to deliver S$3.2bn (20% of orderbook) from its orderbook in 2H20.

Financial leverage remains low; generated S$1.0bn of operating cash flows in 1H20.

  • ST Engineering’s net gearing and net debt to EBITDA remained at relatively modest levels, at 0.6x and 1.5x respectively as at June-2020. Operating cash flow during the period was elevated due to favourable working capital changes (receipt of customer advance payments). We believe ST Engineering’s sound balance sheet and access to cheap funding will enable the group to capitalise on M&A opportunities, should they arise.

Revenue guidance reiterated – FY20F revenue expected to fall by 5-15%.

  • ST Engineering should be able to meet its full-year guidance with ease, given that orderbook related revenue in 2H20 will bring its full-year revenue to at least S$6.8bn (-14.0% y-o-y). Barring any unforeseen project delays and contract cancellations, we project ST Engineering’s FY20F revenue to come in at S$7.0bn, after factoring in some spot contracts in 2H20.

Aerospace division will be a key drag for the next few years.

  • Activity levels at ST Engineering’s hangars globally are currently trending at 65% utilisation, down from near full utilisation at the start of the year, and up slightly from 60% in 2Q20. We believe that ST Engineering’s aerospace sector will only recover to pre-COVID19 levels in late 2021-early 2022 at the earliest, due to the acute reduction in global aircraft fleets and flight activity.
  • In the meantime, ST Engineering will focus on
    1. stringent cost-cutting measures and enhancing productivity improvements,
    2. streamlining its aerospace portfolio to moderate its exposure to businesses that will experience a protracted downturn because of the pandemic, and
    3. ramping up operations that are more resilient like its passenger-to-freight (P2F) line which is benefitting from cheaper feedstock and strong freighter demand following the boom in e-commerce as well as clean cabin solutions which will facilitate safer travel post COVID.

Weak demand for satellite communication solutions will weigh on electronics segment.

  • The sectors that ST Engineering’s satellite communications solutions are dominant in, such as commercial aerospace, cruise lines, and sports events will all be adversely impacted for an extended period. However, we expect strong demand for smart city and mobility offerings, safe access control management, and cybersecurity solutions to continue driving growth as lockdowns and restrictions abate globally.

Maintain FY20F dividends per share (DPS) estimate of 15.0Scts/share.

  • ST Engineering declared interim DPS of 5.0Scts/share, which is consistent with the previous years. Despite the hit to its earnings in FY20F, we expect full-year DPS to be flat at 15.0Scts/share on the back of ST Engineering’s robust operating cash flows and healthy balance sheet and retained earnings position.

Maintain Target Price and HOLD call on limited upside.

Suvro Sarkar DBS Group Research | Jason SUM DBS Research | https://www.dbsvickers.com/ 2020-08-17
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