ST Engineering - UOB Kay Hian 2021-05-14: JV With Major Shareholder Could Lead To Greater Opportunities

SINGAPORE TECH ENGINEERING LTD (SGX:S63)

ST Engineering - JV With Major Shareholder Could Lead To Greater Opportunities

ST Engineering did not guide on 2021’s revenue or earnings but mainly stated that cost savings initiatives were on track. Still, we note that current orderbook at S$15.7b is higher than pre-COVID-19 levels, which adds to confidence of a recovery.
We are also highly positive on ST Engineering’s announcement of the freighter leasing JV with Temasek. Aside from tapping into lower cost of funding and the likelihood of healthy margin, ST Engineering will benefit from adjacent maintenance, PTF work and fee income.
Upgrade ST Engineering to BUY. Target: S$4.07.

ST Engineering (SGX:S63) had previously guided that it planned to achieve S$180m in cost savings, S$70m in earnings from business recovery and lower impairment for 2021 in order to offset the impact from a reduction in government grants. As at 1Q21, cost savings were guided to be slightly better expected, but ST Engineering also indicated that it is prepared to lower the cost savings initiatives if business recovers.
ST Engineering’s orderbook as at end-1Q21 amounted to S$15.7b, up from S$15.3b as at end-20. The company secured S$1.55b in new orders in 1Q21, but this did not include orders with customer confidentiality. We estimate that 2021 net profit will decline by 5.4% y-o-y, after factoring in cost-reduction initiatives.

Aircraft utilisation levels remain low and this would have affected ST Engineering’s airframe maintenance business in the US and Singapore. However, IATA expects a recovery in 2H21, which could initially lead to higher airframe maintenance, though engine and component MRO is likely to lag. Airbus expects an average production rate of 40 A320s in 2H20, and this is expected to pick up to 43 by 3Q21.
Correspondingly, this should benefit ST Engineering’s nacelle manufacturing and aircraft floor panel businesses. However, as at end- 1Q21, Airbus’ A320 deliveries only amounted to 104 aircraft.

ST Engineering guided that the US$600m 50:50 JV will initially have a 60:40 debt/equity structure which implies ST Engineering’s equity commitment of just US$120m. ST Engineering plans to lease at least 25 aircraft over a five-year period, with duration of lease ranging from 5-10 years. The JV will acquire Airbus A320 narrow-bodied aircraft, while ST Engineering will perform the freighter conversion work. The JV will then lease the aircraft, while ST Engineering will receive a management fee from the JV and receive maintenance reserves from the lessee. ST Engineering plans to securitise the aircraft leases and subsequently recycle its capital. We are positive on the venture for three reasons:
1. By forming a JV with Temasek, ST Engineering will be able to achieve a better credit rating with low cost of funds. We also believe that there is scope for even higher leverage as other leasing companies have net debt/equity of 3.0x or more.
2. The JV will allow ST Engineering to provide value-added services such as maintenance work, pax to freighter (PTF) conversion work and receive a management fee of roughly 3-5%.
3. We believe that the JV will be able to achieve lease rate factor of at least 12% and net lease margin of at least 9% (inclusive of 8% tax) with low residual value risk.

This includes rail and road mobility and congestion management. ST Engineering indicated that its focus markets are in Southeast Asia, North Asia and the Middle East. ST Engineering also indicated that it is also open to other acquisitions to expand its capability.

ST Engineering’s reassertion on cost savings along with a partial business recovery and a new JV with Temasek should lead to a favourable re-rating on the stock. We now estimate that ST Engineering would decline by 5.4% y-o-y, vs a 6.5% decline previously.

We raise out 2021 net profit forecast by 1.6%, factoring in marginally lower opex. We have also raised 2022 net profit by 2% factoring in improved margins.

Upgrade ST Engineering to BUY, with target price of S$4.07. We continue to value ST Engineering on an EV/Invested Capital basis. However, we have raised our long-term growth rate to 3.2% from 3.1%. This, together with an upward revision in earnings, has led us to raise our fair value. (previously S$4.00)
See

K Ajith UOB Kay Hian Research | https://research.uobkayhian.com/ 2021-05-14

SGX Stock Analyst Report BUY UPGRADE HOLD 4.07 UP 4.000