ST Engineering - UOB Kay Hian 2021-01-21: Aerospace Division Secures Two Key Contracts, But Recovery Trajectory For 2021 Is Still Uncertain

SINGAPORE TECH ENGINEERING LTD (SGX:S63)

ST Engineering - Aerospace Division Secures Two Key Contracts, But Recovery Trajectory For 2021 Is Still Uncertain

We highlight 3 developments of ST Engineering:
1. a 5-year maintenance contract from an international cargo carrier, which we surmise is FedEx;
2. ST Engineering has been appointed exclusive maintenance provider for Honeywell’s components on the LEAP Engines for 10 years; and
3. the US imposes additional tariffs on Airbus’ components, which could impact ST Engineering’s nacelle production.
While positive on the first two announcements, on-going trade tensions and a delay in border openings could hinder ST Engineering's 2021 earnings recovery.
Maintain HOLD. Target price: S$3.65. Suggested entry range: S$3.40-3.45.

While no details were provided, ST Engineering (SGX:S63) indicated that “it will provide heavy maintenance support for multiple fleet types for the carrier at the group’s airframe facilities in Mobile, Alabama, US, and other locations in the group’s network”.
In addition to heavy maintenance, ST Engineering will also cater to the carrier’s needs for landing gear replacements as well as special maintenance visits of various aircraft types at its Mobile facility.
Given that the maintenance will be provided in the US, we surmise that the unnamed customer would be either UPS or FedEx. As UPS was already a launch customer for ST Engineering’s hangar at Pensacola for the maintenance of B757 freighters, we reckon that FedEx is the likely customer.
ST Engineering had previously performed pax to freighter (PTF) conversions for the carrier and its hangar at Mobile Alabama is also certified to perform maintenance checks for most of FedEx’s wide-bodied aircraft. While ST Engineering will not be the sole maintenance provider, the incremental revenue could still be substantial, given FedEx’s hefty maintenance bills and growth prospects.

The 10-year licence allows ST Engineering to provide engine component MRO for the two leading narrow-bodied aircraft types, A320 NEO and the B737-Max, as well as China’s COMAC C919. This will also complement ST Engineering’s nacelle MRO on the Leading Edge Aviation Propulsion (LEAP) series of engines.
There are currently about 300 A320 NEO aircraft that have been delivered to Asia Pacific customers, and about half of these utilise LEAP engines, with outstanding orders of about 2,800 for the region. Component MRO will be dependent on flight hours, and thus ST Engineering would stand to benefit as early as 2022.

Last week, the US office of US Trade Representatives (USTR) implemented a 15% tariff on imported aircraft parts from EU, in retaliation to the EU imposing tariffs on US aircraft. A prior 10% tariff on aircraft parts was not implemented, but the latest tiff with the EU will include tariffs on imported fuselage and fuselage sections (a fuselage is the body of an aircraft) and wings and wings assemblies. The tariff excludes aircraft sub-assemblies such as floor panels and seats if they are imported unattached.
Airbus currently has an assembly plant in Mobile, Alabama, which manufactures A320 series of aircraft. ST Engineering’s wholly-owned subsidiary MRAS is a single source nacelle manufacturer for the highly popular A320 NEO.
While MRAS might not be directly impacted by the tariffs, Airbus A320 production volumes could take a hit and MRAS’ margins could be indirectly impacted. Airbus currently produces 40 A320NEOS monthly and had plans to raise monthly production to 47 unit by 3Q21.

At this stage, we are unsure if the air cargo heavy maintenance contract and PTF conversions will offset any reduction in MRAS’s production volumes or a delay in recovery passenger aircraft’s heavy maintenance in 2021.
In the US, a resurgence in COVID-19 infections has led to airlines scaling back on capacity additions, and according to OAG’s latest data, seat capacity for Jan 21, stands at just half of pre-pandemic levels. Thus, the much anticipated recovery in heavy maintenance and engine checks could be pushed back to 2H21. We have currently assumed that non-MRAS aerospace revenue would rise 12% y-o-y in 2021.

We do not expect the underperformance to reverse as we believe street’s forward estimates are lofty. Consensus estimates a 7% y-o-y rise in earnings for 2021, despite an approximate S$200m-230m y-o-y decline in government grants (mainly from the Jobs Support Scheme).
While ST Engineering has indicated that about half of the variance could come from cost reductions and new business opportunities, there is now reason to be cautious on revenue growth for 2021.
ST Engineering is expected to guide on revenue growth for 1H21 when it announces its results on 19 February. Until then, we see limited stock price catalysts.

There is no change to our 2020 or 2021 net profit estimates. See ST Engineering Share Price; ST Engineering Target Price; ST Engineering Analyst Reports; ST Engineering Dividend History; ST Engineering Announcements; ST Engineering Latest News.
Maintain HOLD with an unchanged target price of S$3.65.
We continue to value ST Engineering on an EV/invested capital basis. At our fair value, ST Engineering will be trading at 26.4x 2021’s earnings.

K Ajith UOB Kay Hian Research | https://research.uobkayhian.com/ 2021-01-21

SGX Stock Analyst Report HOLD MAINTAIN HOLD 3.650 SAME 3.650