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ST Engineering HIGH CONVICTION Company Note Conglomerate │ Singapore │ April 21, 2020 Insert Insert Singapore ST Engineering ADD (no change) Deferring growth Consensus ratings*: Buy 12 Hold 2 Sell 0 ■ Risk of order cancellations in STE’s order book (S$15.3bn) is low, but high Current price: S$3.41 likelihood of deferral especially aircraft maintenance as airlines are grounded. Target price: S$3.86 Previous target: S$4.66 ■ We now expect STE’s earnings to decline by 3% yoy in FY20F (previously Up/downside: 13.3% growth of 12%) as we reflect -30% yoy in aerospace revenue. Reiterate Add. CGS-CIMB / Consensus: -12.5% ■ Our TP is cut to S$3.86, still on blended valuations. YTD share price (-15%) could have priced in concerns of growth pressure. Wait for weakness to buy. Reuters: STEG.SI Bloomberg: STE SP S$1.6bn order win in 1Q20, electronics positive surprise Market cap: US$7,483m STE announced S$1.6bn of orders in 1Q20, comprising S$730m (+62% qoq) of S$10,643m electronics contracts which include smart mobility in India (new market), and data Average daily turnover: US$17.49m analytics from Singapore’s PUB. Aerospace also won S$838m (-24% qoq) of new S$24.65m contracts which include A320 heavy maintenance and CFM56-7B engine contracts from Current shares o/s: 3,120m Chinese airlines and MRO contracts announced during the Singapore Airshow in Feb. Free float: 37.8% *Source: Bloomberg We expect aerospace order momentum to taper in the coming quarters due to Covid. Defence made up 30% of revenue, electronics to see delays Key changes in this note STE also announced that in 1Q20, its land systems division secured phase 2 of the EPS for FY20F-2022F cut by 6-17% contract for the production and supply of the Hunter Armoured Fighting Vehicle (AFV) from the Singapore Ministry of Defence. Defence accounted for c.30% of STE’s revenue Price Close Relative to FSSTI (RHS) in FY19. We forecast land systems to be the key support in this downturn with +17% yoy 4.60 125.0 earnings growth in FY20F (c.17% of group profit). The schedule to ramp up deliveries of 4.10 117.5 AFV previously secured is intact in 2020. We consider electronics as defensive given that 3.60 110.0 3.10 102.5 customer profiles are largely government agencies/large enterprises, but we expect 2.60 95.0 20 delays in progressive completion of large-scale projects/smart cities, affected by global 15 lockdown. 10 5 Vol m Vol Aerospace sensitive to global aviation crisis - GFC and post 9/11 Apr-19 Jul-19 Oct-19 Jan-20 During the GFC in 2008-09, STE’s profit dipped 6% p.a. for two consecutive years in Source: Bloomberg FY08-09, mainly due to aerospace and electronics (impairment of investments). Price performance 1M 3M 12M Aerospace downtrend started in 4Q08 as component and engines (CERO), which is Absolute (%) 10 -18.6 -11.9 more sensitive to changes in flight hours, incurred provision for doubtful debts for the Relative (%) 2.2 2.2 10.5 bankruptcies of Skybus and Sterling Airlines. Revenue for aircraft maintenance (AMM) Major shareholders % held dropped 8.5% yoy in FY09 as airlines deferred maintenance schedules. Post 9/11, Temasek 50.8 aerospace revenue was flat yoy in FY02 but PBT was down 6% yoy due to start-up Aberdeen Asset Management 6.0 losses as well as provision for debts for United Airlines that filed for bankruptcy then. This Capital Research Global Investor 5.5 time, we think provisions for doubtful debts are inevitable but could be lagged in 2H20 or Insert 1H21, if any. We conservatively build in a 20-30% yoy drop in AMM and CERO revenues, reflecting the global lockdown, along with cut in PBT margin to c.8.4% (FY19: 9.6%) for aerospace on weak operating leverage. Perennial pick in the index STE has always been able to perform in line/outperform the MSCI in previous crises, mainly due to diversification of businesses. We believe the -3% yoy earnings variability in FY20F could sustain DPS of S$0.15, making STE a preferred pick in the Singapore index. Financial Summary Dec-18A Dec-19A Dec-20F Dec-21F Dec-22F Revenue (S$m) 6,698 7,868 7,637 8,276 8,724 Operating EBITDA (S$m) 849 1,061 961 1,001 1,154 Net Profit (S$m) 494.2 577.9 559.9 582.8 697.5 Analyst(s) Core EPS (S$) 0.16 0.19 0.18 0.19 0.22 Core EPS Growth (1.6%) 17.0% (3.1%) 4.1% 19.7% FD Core P/E (x) 21.54 18.41 19.00 18.26 15.25 DPS (S$) 0.15 0.15 0.15 0.15 0.17 Dividend Yield 4.40% 4.40% 4.40% 4.40% 4.99% EV/EBITDA (x) 12.44 11.64 12.99 12.38 10.62 P/FCFE (x) 41.21 NA 36.98 20.28 16.19 Net Gearing 3.4% 76.2% 78.7% 72.9% 65.6% P/BV (x) 4.74 4.79 4.56 4.34 4.11 LIM Siew Khee ROE 22.0% 25.9% 24.6% 24.4% 27.7% T (65) 6210 8664 % Change In Core EPS Estimates (13.7%) (17.4%) (5.7%) CGS-CIMB/Consensus EPS (x) 0.93 0.87 0.98 E [email protected] SOURCES: CGS-CIMB RESEARCH, COMPANY REPORTS IMPORTANT DISCLOSURES, INCLUDING ANY REQUIRED RESEARCH CERTIFICATIONS, ARE PROVIDED AT THE END OF THIS REPORT. IF THIS REPORT IS DISTRIBUTED IN Powered by the THE UNITED STATES IT IS DISTRIBUTED BY CGS-CIMB SECURITIES (USA), INC. AND IS CONSIDERED THIRD-PARTY AFFILIATED RESEARCH. EFA Platform Conglomerate │ Singapore ST Engineering │ April 21, 2020 Deferring growth 1Q20 order win could be the peak for 2020 We commend STE’s strong order momentum in 1Q20 but believe most of the contracts were secured pre-global lockdown. Aerospace contracts of S$838m included those announced during the Singapore Airshow in Feb 2020. We note that contract wins typically were stronger during the biennial event. We also note that during the GFC (2008-2009), aerospace contract wins dropped from S$2.1bn in 2007 to S$537m in 2008 and S$394m in 2009. Figure 1: STE secured S$1.61bn of orders in 1Q20 S$m 3200 Quarterly win Aero Elec Land system Marine 2700 2,511 2,118 2200 1,833 1,673 1,000 1,564 - 1,549 1,568 1700 1,420 138 1,361 818 1,252 1,274 1,210 1,112 464 1,140 1,115 1,145 833 449 1200 1,000 730 650 695 185 560 702 490 742 764 480 585 635 435 700 505 351 1,300 1,100 1,000 1,100 770 840 650 809 838 200 443 520 530 510 510 510 590 450 -300 1Q16 2Q16 3Q16 4Q16 1Q17 2Q17 3Q17 4Q17 1Q18 2Q18 3Q18 4Q18 1Q19 2Q19 3Q19 4Q19 1Q20 SOURCES: CIMB RESEARCH, COMPANY REPORTS Figure 2: Contract wins p.a. by segment S$'m Contract win by segment vs. STE net profit S$'m 9,000 600 8,000 500 7,000 400 6,000 5,412 5,041 5,071 5,000 300 4,119 4,019 3,999 4,000 3,706 3,174 200 2,951 3,000 2,739 1,736 100 2,000 1,398 1,000 0 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 Aero Elec Land Marine Net profit (RHS) SOURCES: CGS-CIMB RESEARCH COMPANY REPORTS Risk of order cancellations low but deferal likely We think the risk of order cancellations for its S$15.3bn order book is low as contracts are typically multi-year. Specifically for aerospace, maintenance work is charged by the hour on scheduled flight hours clocked in. As airlines are grounded during the Covid lockdown, we believe there could still be a certain amount of maintenance required in 2Q20, keeping aircraft flight worthy in the event of a recovery. However, judging from the steep global cuts in airline capacity expected by IATA of a 48% yoy decline in RPK in 2020, we do not think MRO services would be unscathed. In addition to Covid, IATA expects the second order of events - recessionary global economy to push global by 33% yoy by 4Q20. This takes into account the reopening of domestic markets by 3Q20 and a much slower restart in the international markets. Therefore, managing costs in order to cover this unprecedented loss in revenues will 2 Conglomerate │ Singapore ST Engineering │ April 21, 2020 continue to be the main concern of the airline industry in 2020, pushing aircraft maintenance to the right. Figure 3: IATA expects S$314m or 55% fall in passenger revenues RPKs RPKs 2020 (vs 2019 Passenger revenue Passenger revenue 2020 (vs 2019 yearo yearo n-year US$ billion 2020 vs. US$ billion 2020 vs. n-year change) change) 2019 levels 2019 levels Forecast on 14 Apr 2020 Forecast on 24 Mar 2020 Asia-Pacific -50% -113 -37% -88 North America -36% -64 -27% -50 Europe -55% -89 -46% -76 Middle East -51% -24 -39% -19 Africa -51% -6 -32% -4 Latin America -49% -18 -41% -15 Industry -48% -314 -38% -252 SOURCES: CGS-CIMB RESEARCH, IATA Figure 4: STE order book is strong at S$15.3bn, key question is drawing down momentum S$bn 15.9 16 15.6 15.3 15 14.1 14 13.413.4 13.5 13.413.4 13.2 13.2 13.3 13.313.2 13.313.2 13 13 12.7 12.7 12.5 12.5 12.5 12.3 12.4 12.2 12.1 12.2 12.2 12 11.8 11.7 11.5 11.511.6 11.6 11.3 11.3 11.4 11.0 11 10.8 10.8 11 10.6 10.7 10.310.3 10 9 8 SOURCES: CGS-CIMB RESEARCH, COMPANY REPORTS Then and now Aerospace sensitive to global aviation crisis - GFC and post 9/11 During the GFC in 2008-09, revenue for aerospace aircraft maintenance (AMM) dropped 8.5% yoy and component engine (CERO) dipped by 6.6% yoy.
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