ST Engineering (STE:SP) Fair Value: S$4.30
ST Engineering (STE:SP) Rating: Outperform
SIA Engineering (SIE:SP) Fair Value: S$4.50
SIA Engineering (SIE:SP) Rating: Outperform
26 February 2018, Singapore – ST Engineering (SGX:S63)’s stock is oversold recently (down 10% since August 2017 peak) considering that its orderbook did not decline that much (down 2% since 2Q17) in the past 2 quarters and should still support its long-term growth. The contracting momentum for the Electronics segment has been stronger than expected whereas the Aerospace segment’s contracting momentum has weakened which could become a concern if this persists. ST Engineering’s valuations and net profit margins have returned to their historical average levels since year 2000. For investors to re-rate the stock higher, ST Engineering will have to deliver stronger profitability. Around S$110m or 2% of ST Engineering’s total revenue is spent on Research & Development each year and we expect ST Engineering to reap the fruits of its investments in digitalization in the longer term.
STOCK OVERSOLD IN THE PAST 6 MONTHS CONSIDERING ST ENGINEERING’S FIRM ORDERBOOK
ST Engineering (STE:SP)’s stock is oversold in the past 6 months (down 10% from its peak in August 2017) considering that its orderbook did not decline that much (down 2% since 2Q17) in the past 2 quarters. ST Engineering’s relatively firm orderbook should support its revenue growth.
Chart: ST Engineering – Share price versus orderbook trends (1Q05 to 4Q17)
STRONGER AEROSPACE, ELECTRONICS AND LAND SYSTEMS PROFITS WERE OFFSET BY THE MARINE SEGMENT’S DECLINE DURING 4Q17
ST Engineering’s 4Q17 results are in line with our forecast. The stronger profits from the Aerospace (+14% y/y), Electronics (+2%) and Land Systems (+57%, boosted by the favourable impact of the US tax reform) segments were offset by the weaker Marine segment (-95%) during 4Q17. Consequently, Group net profit fell 1% y/y to S$169m in 4Q17, raising full year net profit to S$512m, 6% higher y/y.
Half of ST Engineering Group’s pre-tax profits were contributed by the Aerospace segment. Aerospace contributed 51% of Group pre-tax profits in full year 2017, similar to a year ago. Electronics segment’s pre-tax profit contribution fell 1ppt y/y to 34%. Land Systems accounted for 14% of pre-tax profits, +8ppts y/y, while the Marine segment contributed only 3%, down 10ppts y/y.
Chart: ST Engineering – Net profit growth (decline) of each business segment in past 5 years (2013 to 2017)
STRONG PICK-UP IN WORKLOAD FOR THE TWO SINGAPORE MRO GIANTS
Both ST Engineering (SGX:S63) Aerospace and SIA Engineering (SGX:S59) reported stronger profits during the Oct-Dec 2017 quarter. Comparing the two Singapore MRO giants’ results, ST Engineering Aerospace’s recurring growth of 14% was stronger than SIA Engineering’s 9% growth in Oct-Dec 2017. ST Engineering Aerospace also achieved higher profit margins – its EBIT margin was 11% versus SIA Engineering’s 7% in Oct-Dec 2017. ST Engineering Aerospace’s share of profits from associates and joint ventures has increased to 13% but this is still much smaller than the SIA Engineering’s whose associates and joint ventures contributed 68% of its pre-tax profits in Oct-Dec 2017, mainly boosted by a pick-up in workload at SAESL, SIA Engineering’s engine MRO joint venture with Rolls-Royce.
AIRFRAME MRO, COMPONENT REPAIR, PTF CONVERSION, ADDITIVE MANUFACTURING TO DRIVE FUTURE AEROSPACE SEGMENT GROWTH BUT RECENT WEAKER CONTRACTING MOMENTUM COULD BECOME A CONCERN IF IT CONTINUES
We remain positive on the Aerospace sector outlook which will benefit from rising aircraft utilisation and renewed interest in passenger-to-freighter conversions as the global air cargo market demand has been stronger than expected. Future earnings growth drivers for ST Engineering Aerospace are wide-ranging and include A and C checks for Boeing B777 and B747 aircraft, support for MD-11F for Lufthansa Cargo and Airbus A320 aircraft, ATR 72-500 shipsets, landing gear repair for military planes, engine wash services, B787 component support for Gulf Air, pilot training, A320/A321/A330 passenger-to-freighter conversions for DHL, Vallair and Guangdong Aerocity, aircraft interior manufacturing and retrofit solutions, 3D printing of aircraft parts and blockchain-enabled point-of-use, time-of-need digital supply chain solutions.
However, ST Engineering Aerospace’s recent weaker contracting momentum is on the disappointing side. It secured contracts amounting to S$510m in 4Q17, down 4% q/q and 39% lower y/y. This weaker contracting momentum is a concern if it continues.
Chart: Comparing ST Aerospace and SIA Engineering’s financial results (Oct-Dec 2017)
STRONG CONTRACTING MOMENTUM TO SUPPORT FUTURE GROWTH IN ELECTRONICS SEGMENT – SMART CITY SOLUTIONS, RAIL ELECTRONICS SYSTEMS, SATCOM SYSTEMS, IN-FLIGHT CONNECTIVITY USING SATELLITE ANTENNA SYSTEMS WILL BE THE KEY DRIVERS
The Electronics segment profits tend to be lumpy and contract-driven. 4Q17 sales mix was less favourable, resulting in lower revenue and limited net profit growth. However, ST Engineering Electronics’ recent strong order momentum should support its long-term growth. ST Engineering Electronics’ secured contracts rose to S$742m in 4Q17, up 27% q/q and 7% higher y/y.
Future earnings growth drivers for ST Engineering Electronics include rail electronics systems for Thailand and the region, Communications Systems and Control Systems for Singapore’s Circle Line MRT Stage 6 and the Kim Chuan Depot Extension, VT iDirect Hub in Somalia and Mexico which enables high speed satellite connectivity and data application, launch of the first VT iDirect DVB-S2X network in Russia, deployment of VT iDirect’s Velocity Infrastructure, smart sensor network system for Arad Technologies in Israel, smart cities management in China, Europe, India and the US, comprehensive electronics system for Raffles City in Chongqing (China), communications system in 12 hospitals in Hong Kong.
ST Electronics, through its new joint venture with SatixFy UK Limited, will enhance its satellite communications business with its plans to develop a state-of-the-art satellite antenna system that delivers enhanced in-flight connectivity (IFC) for commercial aviation at significantly lower cost than existing solutions. In addition to providing enhanced broadband connectivity experience for in-flight passengers, the technology will improve operational efficiencies of commercial and business airline operators. If successfully executed, this could be a good revenue opportunity for ST Electronics. See our recent reports below:
LAND SYSTEMS SEGMENT TO GROW MODERATELY WHILE MARINE SEGMENT WILL CONTINUE TO BE A DRAG NEAR TERM
The operating outlook will remain challenging for ST Engineering Marine segment near term given the excess global shipbuilding capacity, potential cost overruns and lack of economies of scale and additional provisions when embarking on the construction of new vessel types. We expect ship repair, defense contracts, smart shipyard solutions and desalination plant in Singapore to be the future growth drivers.
We are more optimistic about ST Engineering Land Systems segment and see future growth being driven by rising defense contracts, Terrex 2 and new Ground combat vehicle contracts and broader deployment of its Aethon robots in the hospitality, medical, logistics and industrials automation sectors in Singapore and overseas.
Chart: ST Engineering – Defense revenue contribution (1Q07 to 4Q17)
REDUCING DIVIDEND PAYOUT RATIO TO KEEP MORE CASH FOR INVESTMENTS IN NEW TECHNOLOGIES AND COMPLEMENTARY BUSINESSES
ST Engineering generated higher positive free cash flows amounting to S$518m in 2017, 5% more than in 2016. However, ST Engineering is ramping up its investment in new technologies and strategic acquisitions that complement its core businesses as well as in disruptive technologies. Therefore, it is pragmatic for ST Engineering to maintain its S$0.10 final dividend per share, similar to its final dividend in the past two years, raising its total dividend per share to S$0.15, steady y/y, implying a dividend payout ratio of 91%, down from 96% in 2016. We expect ST Engineering to comfortably sustain a dividend yield of 4% per annum given its strong operating cash flows and low net debt-equity level.
VALUATIONS ARE BACK AT HISTORICAL AVERAGE LEVELS
ST Engineering is trading at 20x P/E, back to its historical average valuation since year 2000. Interestingly, ST Engineering’s 4Q17 net profit margin has also returned to its historical average net profit margin of 10%. For investors to re-rate the stock higher, ST Engineering will have to deliver stronger profitability.
Chart: ST Engineering P/E Valuation Range (2000 to 2017)
Chart: ST Engineering Historical Net Profit Margin (2000 to 2017)
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.
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