• BUY, new SGD4.60 TP from SGD4.80, 13% upside, 4% yield. ST Engineering should deliver defensive growth, aided by a revival in global aviation traffic, gains from growing demand for smart-city solutions, and rising global defence spending. While 1H22 core earnings were below expectations, its strong order wins and record-high orderbook should keep investors interested. While recent M&A increased its operating costs and debt burden, we believe the acquired businesses will support medium- term profit growth. We expect 8% core profit CAGR in 2021-2024F.

• 1H22 core profit was below expectations. While profit of SGD280m accounted for 46% of our estimates, it included a pre-tax one-off pension restructuring gain of SGD72m. Core net profit of SGD226m (-18% HoH, - 24% YoY) accounted for 37% of our estimates. Commercial Aerospace (CA) continued to register revenue growth (+24% YoY) in 1H22, aided by increased MRO services and nacelle deliveries. STE shared that while airframe MRO hangars are full, engine and component MRO business should continue to recover in 2H22. The key margin disappointment came from the Urban Solutions & Satcom (USS) segment, which reported EBIT loss amidst transaction and integration costs for TransCore and impact from chip shortages. STE announced an interim dividend of 4 cents.

• Strong order wins and record orderbook. STE won new contracts of SGD3.1bn in 2Q22 (+69% YoY, +28% QoQ). Strong order wins were reported by its Defence & Public Security (DPS) and CA businesses. STE reported its highest order backlog of SGD22.2bn, which implies a book-to-bill ratio of 2.7 years – SGD4.6bn of this order book is expected to be delivered in 2H22, representing 100% of our 2H22 revenue estimates.

• Higher near-term costs from TransCore acquisition. USS revenue increased SGD757m (+14% HoH, +43% YoY) aided by contribution from the TransCore acquisition and higher smart city deliveries. However, the business registered an EBIT loss amidst: i) TransCore transaction and integration expenses of SGD21m, ii) lower government support of SGD3m and iii) weaker performance of Satcom, caused by semiconductor chip shortages. TransCore is expected to keep operating costs elevated (annual integration costs of SGD10m) as well as the debt burden (additional SGD700m of borrowings). We believe TransCore will also support STE’s medium-term profit growth in the USS business.

• Adjusting earnings. We lower 2022F core net profit by 9% to account for the one-off gain and 2023F-2024F profit by 1% and 2%. Our TP is derived by using an average of P/E, P/BV, EV/EBITDA and DCF of FCF. Our TP includes an ESG premium of 8% over the fair value of SGD4.26.

Source: RHB Research - 15 Aug 2022