ST Engineering – Tailwinds from higher security spending, MRO demand September 26, 2023 691

PSR Recommendation: BUY Status: Initiation
Last Close Price: 4.37 Target Price: 4.500
  • Singapore stepped up defence and security spending by 12% and 17% in FY21 and FY22, respectively. This is expected to rise further, fuelled by heightened geopolitical tensions and cybersecurity threats, providing revenue visibility for STE. Total contracts won for defence and security amounted to S$5.2bn in 1H23, 20.9% higher than the whole of FY22.
  • Recovery in air travel will underpin demand for aerospace MRO and components. According to IATA, air passenger-km is still 9.7% below pre-Covid. Asia Pacific’s volume is still 20.3% below, and playing catch-up.
  • TransCore’s acquisition is on track to be earnings accretive from 2H23e, we believe, leading to a positive FY23e EBIT for the urban solutions and Satcom division.
  • We initiate coverage with a BUY recommendation and discounted cash flow TP of S$4.50.

 

 

Highlights

  • Defence spending to climb in the face of heightened geopolitical tensions and cybersecurity threats. Singapore’s defence and security spending expanded by 12% YoY in FY21 and 17% in FY22, well exceeding the 4% average annual growth from 2010-2020. It is expected to rise by 6% in FY23e. As a key Singapore defence contractor, STE will enjoy revenue visibility as more contracts are awarded. STE won S$5.2bn of new orders in 1H23 for defence and public security work. This was 20.9% higher than FY22.

 

  • Aviation recovery to fuel demand for MRO and aircraft parts. The aviation sector has bounced back since borders re-opened. Demand for aircraft MRO and components are rising in tandem with increased flight hours and de-mothballing of idle aircraft. According to IATA, total industry passenger-km rose 47.2% YoY in 1H23, though this was still 9.7% below 1H19. Asia-Pacific, which was last to re-open, lags at 20.3%. As Asian air travel gains pace from 2H23e, STE’s MRO bases in China, Vietnam and Singapore are poised to gain from higher demand for MRO and components.

 

  • TransCore is on track to be earnings accretive. TransCore was acquired in Mar 2022 for S$3.6bn, at a goodwill of S$2.3bn. It booked a net profit of S$61.9mn from Mar to Dec 22. However, this was negated by transaction and integration expenses (FY22: S$30mn, 1H23: S$8mn), increased interest costs and goodwill amortization. In June 2023, TransCore received the notice-to-proceed for the New York Congestion Pricing project, scheduled for completion by 2Q24e. We think this project could lead to more opportunities in other US cities. Transcore is on track to be earnings accretive from 2H23e with contribution from this project and the fading of transaction and integration expenses.

 

Initiate coverage with a Buy recommendation and TP of S$4.50.

Our TP is based on the discounted cash flow model. The operations generate strong cash flows. We expect it to deliver ROE and ROIC of 26.1% and 14.6% in FY24e.

 

Orderbook

As at end Jun 23, the orderbook stood at a record S$27.7bn. New order wins grew by 11.3% CAGR from FY19 to FY22 (Figure 1). Total orders won in 1H23 were S$9.5bn, comprising 54% defence and public security contracts, 32% commercial aerospace and 14% urban solution and Satcom (Figure 2).

 

 

Background

 

ST Engineering is a global technology, defence and engineering group with a diverse portfolio of businesses across the aerospace, smart city, defence and public security segments. Though STE has built a reputation for strong research and development capability in advanced defence and mobility technologies, about two-thirds of revenue is derived from commercial projects (Figure 3).

 

Figure 3: 67% of revenue is derived from commercial jobs

 

 

Asia is its biggest market (Figure 4) and Singapore is an important market where it supports defence and public infrastructure projects. In Europe, it has a strong presence in Germany and Ireland due to its tie-up with Airbus for the passenger-to-freighter, or PTF conversion programme.

 

 

 

Revenue bounced back after the lull in FY20 when it faced delays in project execution and order deferment. Strong recovery in commercial aerospace, and the acquisition of TransCore in March 2022, which added revenue of S$620mn, more than offset the loss of revenue from US Marine which was divested in FY22.

 

STE has set a revenue target of S$11bn for FY26e (Figure 5), of which S$3bn will be derived from sustainability-linked projects. Revenue growth is projected at 2 to 3 times the global GDP growth rate.

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