• BUY, SGD4.15 TP, 20% upside, with c.5% FY23F yield. ST Engineering’s aerospace business should see a strong recovery in MRO revenues amidst the earlier and faster-than-expected relaxation of China’s zero-COVID policy. While global demand for air cargo is tailing off, there are limited downside risks as its P2F conversion slots are fully booked until 2025-2026. Growth in other segments and contributions from new businesses should enable it to see an 8% profit CAGR in 2021-2024F. We like STE for its strong revenue visibility and defensive dividend outlook.

• China’s reopening should help revive aviation traffic. As per data from RadarBox, domestic aviation traffic in China has seen a strong rise since the start of this year, and the 7-day average (15-22 Jan) domestic flight traffic in China is already above the pre-pandemic levels recorded in 2019. China’s surprise decision to drop border curbs earlier (from 8 Jan onwards) has given the industry a boost, with some experts believing that the country reopening its doors to international travel could propel global air traffic back to pre-pandemic levels as soon as Jun 2023. While we remain optimistic about the outlook, we believe that some countries' reintroduction of tougher measures and COVID-19 testing for passenger arrivals will result in a more gradual recovery in international aviation traffic. China's aviation regulator wants passenger traffic to reach around 75% of pre-pandemic levels this year, from 38% in 2022.

• Recovery in aviation traffic should boost demand for MRO services. The gradual reopening of China's aviation traffic should result in a much faster recovery in short-haul travel, particularly within the country and to neighbouring Asian and South-East Asian countries. A return to service checks and higher aircraft utilisation should boost MRO needs, which will be positive for service providers, especially in Asia. STE is the world's largest airframe MRO solution provider, with a strong presence in China and a greater exposure to narrow-body aircraft. The company offers airframe and engine services along with freighter conversions in China.

• Still positive on growth outlook and steady dividends. STE's outstanding orderbook is at an all-time high of SGD23.1bn, providing over two years of revenue visibility. Despite concerns on cost inflation and higher interest expenses, we believe STE will continue to pay 4 cents of quarterly DPS, implying a yield of c.5%. We continue to derive our TP using an average of P/E, P/BV, EV/EBITDA, and DCF. The TP of SGD4.15 includes an 8% ESG premium over the fair value of SGD3.85.

Source: RHB Research - 19 Jan 2023