14 Sep 2018, Global – ST Engineering just announced its US subsidiary VT Aerospace’s plans to acquire a 100% stake in US-based engine nacelle OEM MRA Systems (MRAS) from General Electric for a total consideration of US$630m (or S$868m). We view this milestone acquisition positively and reiterate our Buy rating (target price S$4.30) on ST Engineering which is a defensive play in these volatile markets. 20% of ST Engineering’s revenue are derived from the US (which will rise to 30% following this transaction based on our estimates) and it is a beneficiary of the stronger US dollar and US tax cuts. This transaction will be subject to regulatory approvals from the Committee on Foreign Investment in the US and anti-trust approvals in the US, France and Brazil.
Acquisition Price is Highly Attractive and Value-Accretive
This acquisition is a bargain for ST Engineering in our view, likely helped by General Electric’s urgency to divest its assets to improve its financial position, as it values MRAS at 10x EV/EBITDA, 1.2x EV/Sales and 13x P/E based on our estimates. This is a 35% discount to the average current valuation of the global nacelle manufacturers and ST Engineering’s own valuations.
We view this development positively and expect the acquisition to be value-accretive for ST Engineering, boosting its Aerospace segment’s earnings growth in the coming years. On a pro-forma basis, MRAS would boost ST Engineering’s pre-tax profit by S$33.2m or 11.3% in 1H18.
Marks Major Milestone in ST Engineering’s Aerospace Capabilities
This will be mainly driven by MRAS’ portfolio of single-source contracts, led by its Nexcelle joint venture with Safran Nacelles, which supplies engine nacelles, one of the first aerostructures to exploit the use of composite materials, to the bestselling new generation Airbus A320neo aircraft (which has 57% market share of global narrowbody aircraft orders) that are powered by the CFM LEAP 1-A engine. 38% of the 6068 A320neo aircraft orders have selected the CFM LEAP-1A engine so far, 27% the P&W GTF engine and the remaining 35% unannounced.
MRAS has delivered 500 LEAP-1A engines so far and the A320neo production rate is expected to grow from 55 units currently to 63 units per month by mid-2019 which will improve MRAS’ productivity and earnings contribution to ST Engineering. We forecast the global Airbus A320neo aircraft fleet to grow 36% per annum in the next 10 years based on their existing orders.
The Thrust Reverser Actuation System and Engine Build-Up components that MRAS supplies also tends to have a shorter lifespan compared to other major nacelle components which will benefit ST Engineering’s after-market spare parts sales and repair revenue in the longer term.
Chart: Airbus A320neo aircraft fleet expansion (2017 to 2027)
Other single-source programmes in MRAS’ portfolio, in collaboration with Safran Nacelles, include COMAC’s C919 powered by the CFM LEAP-1C turbofan engine, COMAC’s ARJ21 powered by the GE CF34 engine and Bombardier’s Global 7000/8000 series of next generation business jets. See our previous report on the substantial COMAC aircraft orders in China:
MRAS also holds other key technologies and patents including the Hidden Blocker Door Thrust Reverser, Composite Materials – Automated Fibre Placement, Electric & Directed Flow Anti-Ice Systems, Low Drag Acoustic Liners.
Singapore MRO Players to Play More Significant Role in Bestselling Airbus A320neo After-Market
ST Engineering’s upstream acquisition of MRAS and SIA Engineering’s selection as a Maintenance, Repair & Overhaul (MRO) facility in Singapore for the Pratt & Whitney PW1100G-JM PurePower® Geared Turbofan™ (GTF) engines, which is the other engine type that powers the Airbus A320neo aircraft, imply that the two Singapore MRO players have the capability to service both engine types that power the bestselling A320neo aircraft, raising their significance in the A320neo after-market in the coming years.
This will position ST Engineering and SIA Engineering well in the global engine MRO market for A320neo aircraft as the Asia Pacific region will be the home to the largest number of A320neos with 39% market share.
Chart: Distribution of Airbus A320neo aircraft by airline operator region
See our previous report below for more details:
Special Dividends are Unlikely given ST Engineering’s Quest for More Proprietary Technologies & Capabilities-Enhancing Acquisitions
This MRAS acquisition will be funded by ST Engineering’s internal cash balance and debt. We believe ST Engineering can support a regular annual dividend of S$0.15 per share, implying a yield of 4.5% but special dividends are unlikely, in our view, as its quest for more proprietary technologies and capabilities-enhancing acquisitions will continue.
Key Downside Risks
Potential reduction in new nacelle contracts growth if Airbus in-sources nacelle manufacturing for its A320neo aircraft.
China imposes tariffs on nacelle imports which are used in the CFM LEAP 1-C turbofan engine that powers the COMAC C919 aircraft and the GE CF34 that powers the COMAC ARJ21 aircraft.
COMAC decides to in-source nacelle manufacturing.
Needs to foster close partnership with General Electric, Airbus, Boeing and other OEMs and invest in new technologies for 90 year old MRAS to stay relevant and cost competitive in the longer term.
Note: Stocks with upside of more than 10% based on our fair value are assigned an Outperform rating. Stocks with downside of more than 10% based on our fair value are assigned an Underperform rating. Stocks with upside or downside of less than 10% based on our fair value are assigned an In-line rating. These are Crucial Perspective’s proprietary rating classifications and by no means serve as investment recommendations.
Independent Research Declaration: Crucial Perspective does not own any position in the equities featured in this report nor have we received any compensation for writing this report.
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