Initiating Coverage Singapore 6 September 2017 Industrial | Aerospace & Defence Buy ST Engineering Ltd Target Price: SGD4.07 Price: SGD3.59 There Is Growth Beyond 2017 Market Cap: USD8,250m Bloomberg Ticker: STE SP We initiate coverage on ST Engineering with a BUY and SGD4.07 TP (13% Share Data upside). Its exposure to the commercial and defence industries across Avg Daily Turnover (SGD/USD) 10.2m/7.46m four segments creates a defensive business model that is tough to beat. It 52-wk Price low/high (SGD) 3.05 - 3.85 is world’s largest MRO service provider for aircraft and Asia’s leading provider of ICT solutions. Aircraft fleet size growth, rising demand for P2F Free Float (%) 49 conversions and more spending on Smart Nation initiatives should lead to Shares outstanding (m) 3,122 strong 2018 growth. While a 4% yield could support the stock, strong Estimated Return 13% order wins and accretive M&As may act as near-term catalysts. Shareholders (%) Expectations of higher YoY order inflows. ST Engineering’s outstanding Temasek Holdings 50.8 highest-ever orderbook of SGD13.5bn provides revenue visibility for 2017 and Aberdeen 5.0 2018. This is as the book-to-bill ratio stands at c.2x. We believe the group could Capital Group 3.2 achieve SGD5.5bn in new orders in 2017 (2016: SGD5bn), as it has already announced SGD2.7bn worth of order wins in 1H17. Share Performance (%) Aerospace to ride on long-term aircraft fleet growth. We believe the long- YTD 1m 3m 6m 12m term growth prospects for ST Engineering’s world-leading MRO business Absolute 11.1 (5.8) (3.8) (1.9) 7.5 remain strong. This as aircraft fleets in China and India are set to grow at 10.6% Relative (1.1) (2.9) (3.6) (5.4) (5.8) and 11.9% respectively in 2017-2027. It is also estimated that the average age Source: Bloomberg of aircraft fleets in China and India would increase to 7.8 years (from 6.1 years) and 10.2 years (6.9 years) respectively. This implies greater need for MRO ST Engineering Ltd (STE SP) checks. We also view positively its exposure to rapidly growing passenger-to- Price Close Relative to Straits Times Index (RHS) freighter (P2F) conversion business. 3.9 105 3.7 102 Proxy to Singapore’s Smart Nation initiative. In May, Singapore announced 3.5 99 3.3 95 a total of SGD2.4bn worth of tenders to be called this year to invest in data 3.1 92 2.9 89 analytics software and a communications backbone. ST Engineering is looking 12 to be the backbone for this network. Its acquisition of 51% of SP Telecom, 10 8 which owns an extensive network of fibre optic back-haul infrastructure and 6 facilities, should enhance its capabilities in delivering Smart Nation solutions. 4 We believe there is potential for growth beyond Singapore, as Frost & Sullivan 2 Volm 16 16 17 17 17 17 - - - - - estimates the global Smart City market at USD1.5trn by 2020. - Jul Jan Mar Nov Sep May Improving outlook with likely higher dividends. Supported by growth in the aerospace and electronics segments, plus land systems’ recovery, the group is Source: Bloomberg set to deliver 10% earnings growth in 2018-2019 (2017: +2%). With rising profit, and limited capex requirement, we believe ST Engineering could gradually increase the 2019 dividend/share to SGD0.17 (2016: SGD0.15). With a dividend yield of 4%, it is as among the few strong dividend-paying blue-chip Table Of Contents Financial Exhibits 2 counters on the SGX with expectations of earnings growth. Investment Thesis 3 Premium valuation for quality. Our SGD4.07 TP is based on the average of Valuation 9 Key Risks 12 P/E-, P/BV-, EV/EBITDA- and DCF-based valuations and implies 23.3x 2018F Segment Outlook 13 P/E, ie slightly above +1SD forward P/E. We believe the premium valuation is Financial Analysis 23 justified, given prospects of earnings recovery and steady dividend yields. Company Background 27 SWOT Analysis 30 Key risks. Sustained weakness in the marine business and delays in order inflows for the aerospace and electronics businesses could lead to lower-than- estimated earnings in 2017-2019. Forecasts and Valuations Dec-15 Dec-16 Dec-17F Dec-18F Dec-19F Total turnover (SGDm) 6,335 6,684 6,748 6,949 7,260 Reported net profit (SGDm) 529 485 495 545 608 Recurring net profit (SGDm) 529 485 495 545 608 Recurring net profit growth (%) (0.5) (8.4) 2.2 10.0 11.5 Recurring EPS (SGD) 0.17 0.16 0.16 0.17 0.19 DPS (SGD) 0.16 0.15 0.15 0.15 0.16 Recurring P/E (x) 21.2 23.1 22.6 20.6 18.5 P/B (x) 5.26 5.14 5.01 4.85 4.61 P/CF (x) 24.1 14.8 11.7 14.1 13.5 Dividend Yield (%) 4.4 4.2 4.2 4.2 4.4 Analyst EV/EBITDA (x) 15.9 15.6 14.2 13.3 12.0 Shekhar Jaiswal Return on average equity (%) 24.8 22.5 22.4 24.0 25.6 Net debt to equity (%) 10.7 7.2 net cash net cash net cash +65 6232 3894 Our vs consensus EPS (adjusted) (%) (2.1) (0.8) 1.9 [email protected] Source: Company data, RHB See important disclosures at the end of this report 1 Powered by the EFA Platform ST Engineering Ltd Singapore Initiating Coverage 6 September 2017 Industrial | Aerospace & Defence Financial Exhibits Financial model updated on: 2017-09-04. Asia Financial summary Dec-15 Dec-16 Dec-17F Dec-18F Dec-19F Singapore Recurring EPS (SGD) 0.17 0.16 0.16 0.17 0.19 Industrial EPS (SGD) 0.17 0.16 0.16 0.17 0.19 ST Engineering Ltd DPS (SGD) 0.16 0.15 0.15 0.15 0.16 Bloomberg STE SP BVPS (SGD) 0.68 0.70 0.72 0.74 0.78 Buy Weighted avg adjusted shares (m) 3,121 3,122 3,122 3,122 3,122 Valuation basis Valuation metrics Dec-15 Dec-16 Dec-17F Dec-18F Dec-19F We use a blended valuation methodology to value ST Recurring P/E (x) 21.2 23.1 22.6 20.6 18.5 Engineering. Our SGD4.07 TP is based on the P/E (x) 21.2 23.1 22.6 20.6 18.5 average values derived from P/E- (23x), P/BV- (5.5x), EV/EBITDA- (16x) and DCF-based valuations (WACC P/B (x) 5.26 5.14 5.01 4.85 4.61 of 6.8% and terminal growth rate of 2%). Our TP FCF Yield (%) 1.7 4.6 6.4 4.9 5.3 implies 23.3x 2018 P/E, which is slightly above +1SD Dividend Yield (%) 4.4 4.2 4.2 4.2 4.4 forward P/E as measured since 1 Jan 2008. EV/EBITDA (x) 15.9 15.6 14.2 13.3 12.0 EV/EBIT (x) 21.8 23.9 19.5 18.2 16.2 Key drivers i. Strong order wins; Income statement (SGDm) Dec-15 Dec-16 Dec-17F Dec-18F Dec-19F ii. Recovery in the marine and aerospace sectors. Total turnover 6,335 6,684 6,748 6,949 7,260 Key risks Gross profit 1,282 1,305 1,329 1,357 1,465 EBITDA 698 718 772 823 909 i. Poor execution of diversification in the aerospace sector; Depreciation and amortisation (187) (247) (211) (222) (233) ii. Long-term slowdown in the shipbuilding Operating profit 510 471 562 601 676 industry; Net interest (16) (15) (18) (15) (13) iii. Delay in the implementation of Singapore’s Income from associates & JVs 58 64 55 56 58 Smart Nation initiative. Pre-tax profit 630 591 644 695 775 Company Profile Taxation (99) (98) (118) (118) (132) Minority interests (3) (8) (31) (32) (35) ST Engineering is an integrated engineering group in the aerospace, electronics, land systems and marine Recurring net profit 529 485 495 545 608 sectors. The company has diversified its businesses and geographic reach over the years. Cash flow (SGDm) Dec-15 Dec-16 Dec-17F Dec-18F Dec-19F Change in working capital (227) (13) 204 (45) (87) ST Engineering’s 1-year forward P/BV vs ROEs Cash flow from operations 465 759 956 794 830 Capex (270) (247) (237) (240) (240) 8.0 33% Cash flow from investing activities (477) (267) (213) (182) (181) 31% 7.0 Proceeds from issue of shares (76) 6 17 0 0 29% Dividends paid (498) (466) (467) (471) (490) 6.0 27% Cash flow from financing activities (519) (535) (491) (511) (531) 25% 5.0 Cash at beginning of period 1,471 951 905 1,136 1,237 23% Net change in cash (531) (44) 252 101 118 4.0 21% Ending balance cash 951 905 1,136 1,237 1,355 19% 3.0 17% 2.0 15% Balance sheet (SGDm) Dec-15 Dec-16 Dec-17F Dec-18F Dec-19F Jan-08 Jan-10 Jan-12 Jan-14 Jan-16 Total cash and equivalents 951 905 1,136 1,237 1,355 Tangible fixed assets 1,709 1,670 1,709 1,760 1,800 P/BV ROE Intangible assets 737 1,020 1,000 967 934 Total investments 462 406 427 370 311 Total other assets 471 457 571 571 571 Total assets 8,169 8,365 8,641 8,829 9,052 Short-term debt 175 87 0 0 0 Total long-term debt 1,019 993 1,027 1,027 1,027 Other liabilities 469 536 516 516 516 Total liabilities 5,908 5,921 6,106 6,188 6,258 Shareholders' equity 2,132 2,182 2,238 2,312 2,429 Minority interests 129 262 297 329 364 Total equity 2,261 2,444 2,535 2,641 2,794 Net debt 242 175 (108) (209) (327) Total liabilities & equity 8,169 8,365 8,641 8,829 9,052 Key metrics Dec-15 Dec-16 Dec-17F Dec-18F Dec-19F Revenue growth (%) (3.1) 5.5 1.0 3.0 4.5 Recurrent EPS growth (%) (0.7) (8.5) 2.2 10.0 11.5 Gross margin (%) 20.2 19.5 19.7 19.5 20.2 Operating EBITDA margin (%) 11.0 10.7 11.4 11.8 12.5 Net profit margin (%) 8.4 7.2 7.3 7.8 8.4 Dividend payout ratio (%) 94.1 96.2 94.3 86.3 80.7 Capex/sales (%) 4.3 3.7 3.5 3.5 3.3 Interest cover (x) 12.8 11.1 13.8 14.9 16.8 Source: Company data, RHB, Bloomberg See important disclosures at the end of this report 2 ST Engineering Ltd Singapore Initiating Coverage 6 September 2017 Industrial | Aerospace & Defence Investment Thesis Strong orderbook position to support revenue growth ST Engineering’s orderbook has seen significant improvement over the last decade.