• BUY, new SGD4.15 TP from SGD4.10, 25% upside with c.4% FY23F yield. ST Engineering has decided to dispose of its loss-making US marine business. While orders for this unit account for c.8% of its total orderbook, outstanding jobs excluding these contracts still provide over two years of revenue visibility. We expect the margin improvement in its defense business to more than offset the revenue decline from this sale. Beyond 2022, STE should deliver a 10% profit CAGR in 2022–2024F, and a steady DPS of 16 cents.

• US marine business exit deal. STE plans to divest its entire stakes in VT Halter Marine (VTHM) and ST Engineering Halter Marine and Offshore to Bollinger Shipyards Lockport for a cash consideration of USD15m (c.SGD21m) on a cash-free, debt-free basis – subject to net working capital adjustments, if any, post-closing. STE may receive earn-out payments of up to USD10.25m, subject to the award of certain future shipbuilding contracts to VTHM, and such contracts meeting the requisite operating profit margins. The proposed divestment is expected to be completed before the end of Dec 2022, and translate into a non-cash loss on disposal of c.SGD13.3m.

• STE’s US marine business has been in the red. STE noted that it had conducted a thorough review of the two US marine businesses. These two units have incurred a combined pre-tax net loss of USD256m (SGD349m) in the last five years (2017-2021), with an annual pre-tax net loss that ranged from about USD40m (c.SGD56m) to USD60m (c.SGD85m).

• Reduction in the orderbook, but this may be positive for the margin outlook. STE’s outstanding orderbook remains strong at SGD25bn at the end of Sep 2022. This includes the orders for the two US marine businesses worth SGD1.9bn, which will be removed from its orderbook after the close of the transaction. Excluding these orders, the group’s outstanding orderbook of SGD23.1bn still provides over two years of revenue visibility. We expect a sharp drop in marine business revenue from 2023, but expect the improvement in defense business margins (due to the sale of the loss-making US marine businesses) to more than offset the revenue decline.

• Strong earnings growth beyond 2022. We increase 2024F earnings by 3%, and maintain that the delivery of STE’s strong orderbook, growing defence revenue and Urban Solutions & Satcom Security’s potentially sharp recovery should support its 14-17% profit growth in 2023-2024F. We continue to derive our TP 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 SGD3.85.

Source: RHB Research - 9 Nov 2022