ST Engineering - UOB Kay Hian 2022-08-15: 1H22 Core Profit Missed; Looking Forward To A Better 2H22

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SINGAPORE TECH ENGINEERING LTD (SGX:S63)

ST Engineering - 1H22 Core Profit Missed; Looking Forward To A Better 2H22

• ST Engineering’s 1H22 headline net profit of S$280m was helped by a number of one-off items. 1H22 core net profit of S$202m was a miss, at 38% of our full-year forecast.
• 2H22 core performance should improve from 1H22, driven by the continued recovery of the Commercial Aerospace (CA) segment and potential higher project delivery by the Defence & Public Security (DPS) segment.
• Cost pressure would weigh on ST Engineering’s core profitability in the medium term. We cut 2022-24 core net profit forecasts by 7.4-9.6%. Maintain BUY with a lower target price of S$4.40.

ST Engineering's 1H22 headline net profit helped by one-off items.

• ST Engineering (SGX:S63)’s 1H22 reported net profit of S$280m (-5.5% y-o-y) was overall positively affected by a number of one-off items, with some major ones being:
  1. a S$72m pension restructuring gain (pre-tax),
  2. favourable fair value changes on corporate venture investments and divestment gains on associates and property, plant and equipment (PPE) totalling S$22.3m,
  3. S$13.4m gain from disposal of subsidiaries, and
  4. transaction costs and integration expenses of S$21m (pre-tax) related to TransCore (acquisition completed in Mar 22).
• Core performance below expectations. Excluding all one-off gains/expenses, ST Engineering’s core net profit of S$202m (by our estimate) came in below expectations, at 38%/35% of our/consensus 2022 full-year projection. 1H22 was almost free of government support (only a minor S$0.5m in 1H22 vs S$125m in 1H21).
• On a y-o-y basis, core net profit (excluding government grants) rose 38.7% on the back of significant profitability recovery in the Commercial Aerospace (CA) segment, higher contribution from Defence & Public Security (DPS) segment, offset by weaker performance in the Urban Solutions & Satcom (USS) segment.
• Group revenue rose 17% y-o-y to S$4.27b in 1H22 (1H21: S$3.65b).

Strong Commercial Aerospace (CA) performance offset by weakness in Urban Solutions & Satcom (USS).

• Commercial Aerospace (CA) revenue rose 23.6% y-o-y to S$1.40b in 1H22 (1H21: S$1.14b), driven by increased Maintenance Repair and Overhaul (MRO) service volume and higher nacelle delivery as the CA segment continues to recover. Excluding the one-off pension restructuring gain, CA operating profit stood at S$103m in 1H22, which exceeded our expectations at 88% of our full-year projection.
• The outperformance was due to the faster-than-expected recovery in operating margin (1H22: 7.3%), which was in turn driven by business volume recovery coupled with a favourable operating margin.
• Urban Solutions & Satcom (USS) revenue rose 43.5% y-o-y to S$0.76b in 1H22 (1H21: S$0.53b), driven by fresh contribution from TransCore but partly offset by lower revenue contribution from ST Engineering’s satcom business. Excluding one-off transaction and integration expenses related to TransCore, USS operating profit was S$11m in 1H22, significantly below forecast.
• According to management, ST Engineering’s satcom and IoT businesses were adversely impacted by the global chip shortage.

Defence & Public Security (DPS) profitability weighed by cost pressure.

• Defence & Public Security (DPS) revenue rose 6.1% y-o-y to S$2.11b in 1H22 (1H21: S$1.99b), driven by higher contribution from Land Systems, Digital Systems & Cyber and Defence Aerospace subsegments but partly offset by slightly lower contribution from the Marine subsegment. DPS operating profit of S$214m (+2.3% y-o-y) was below our expectations at 38% of our full-year forecast.
• We believe the miss was attributable to:
  1. timing of project delivery (we expect higher project delivery in 2H22), and
  2. lower-than-expected operating margin (9.3% in 1H22 vs our 2022 projection of 10.8%) due to cost pressures related to supply chain disruption and higher energy costs.

Net gearing elevated post the TransCore acquisition.

• ST Engineering's Net gearing (excluding lease liabilities) stood at 194% at end-1H22 by our estimate vs 27% at end-21, due to the debt financing for the acquisition of TransCore (acquisition completed in Mar 22).
• According to management, 55% of the borrowings are based on fixed interest rates. Rising interest cost pressure for the floating portion has been duly reflected by our financial projection (we forecast interest expenses of S$112m-142m in 2022-24, vs S$45m in 2021).
• Second interim dividend of 4 cents. In line with the group’s guided policy, ST Engineering declared a second interim dividend of 4 cents per share, payable on 2 Sep 22.

Record-high orderbook of S$22.2b.

• ST Engineering’s orderbook rose further to S$22.2b at end-1H22 (end-1Q22: S$21.3b, end-2021: S$19.3b). ST Engineering won S$3.1b worth of contracts in 2Q22 (1Q22: S$2.4b), comprising
  • S$1.2b contracts for Commercial Aerospace (CA) segment,
  • S$0.4b for Urban Solutions & Satcom (USS) segment and
  • S$1.4b for Defence & Public Security (DPS) segment.
• We expect ST Engineering’s revenue growth to be underpinned by its strong orderbook in the medium term.
• Expecting better core performance in 2H22. We expect ST Engineering’s core profitability to improve in 2H22, driven by:
  1. continued recovery in the Commercial Aerospace (CA) (ST Engineering plans increase nacelle production to 53 sets per month by end-22 vs an average of 48 sets in 1H22), and
  2. expected higher project delivery by the Defence & Public Security (DPS) segment.
• ST Engineering guided to deliver S$4.6b worth of projects from its orderbook in 2H22; this is S$1b higher compared with its project delivery guidance for 2H21 a year ago.
• Some margin pressure likely in the near-medium term. While we expect ST Engineering’s core profitability to improve going forward driven by the Commercial Aerospace (CA) business recovery/growth across all three segments, we note that supply chain issue and inflationary pressure would continue to weigh on ST Engineering’s margins.
• ST Engineering guided that the group would also continue to incur integration costs of S$10-20m p.a. in the next two years, related to the post-acquisition integration of TransCore.

ST Engineering - Earnings forecast revision & recommendation

• We lower 2022-24 core net profit forecasts for ST Engineering by 7.4-9.6%. The cuts were mainly due to lower profit forecasts for Urban Solutions & Satcom (USS) segment (due to integration costs of TransCore) and Defence & Public Security (DPS) segement (lowered margin assumptions due to inflation pressure), partly offset by higher profit forecast for Commercial Aerospace (CA) segment (raised steady-state margin assumptions).
• Maintain BUY recommendation on ST Engineering with a lower DCF-based target price of S$4.40. Current ST Engineering's Share Price of S$4.06 implies 2023F core P/E 22.4x, or 0.6 standard deviation above its historical mean of 21.3x.
• See
  • ST Engineering's Share Price,
  • ST Engineering's Target Price,
  • ST Engineering's Analyst Reports,
  • ST Engineering's Dividend History,
  • ST Engineering's Announcements,
  • ST Engineering's Latest News.
• Catalysts: Core profitability growth on Commercial Aerospace (CA) business recovery/growth and higher Defence & Public Security (DPS) project deliveries.
• Risks include negative margin surprises due to project cost overrun and failure to pass down inflationary cost pressure.

Roy Chen CFA UOB Kay Hian Research | https://research.uobkayhian.com/ 2022-08-15

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