• Reiterate BUY, new SGD5.32 TP from SGD5, 15% upside, and c.3.5% yield. We roll forward our valuation to FY25F. ST Engineering’s share price has outperformed the STI and we expect this outperformance to continue as it remains well positioned to deliver 15% profit CAGR and steady dividends during 2023-2026. This earnings growth will be aided by strong demand for aviation MRO services and a potential recovery in the Urban Solution & Satcom (USS) segment. We see further earnings tailwind from the impending interest rate decline, as c.39% of its debt is exposed to floating interest rates.

• Expect earnings growth momentum to continue. We expect the strong earnings growth reported by STE in 1H24 to continue due to continuing demand for aviation MRO work, which will boost the Commercial Aerospace business in our view. Because of strike action, Boeing's operations have been impacted, and we believe this could make the shortage of jetliners worse worldwide and force airlines to keep using older aircraft for longer. This would, in general, mean more work for both airframe and engine MRO service providers. We also expect higher aircraft engine nacelle deliveries. Airbus expects its A320 production rate to exceed the 45 aircraft per month deliveries achieved in 2023. With improving scale, we also expect STE’s passenger-to-freighter or PTF conversions to see better margins in 2H24. While the USS numbers were below our expectations in 1H24, we maintain that STE’s focus on improving processes and optimising costs should boost EBIT. We expect growth in the Defence & Public Security or DPS segment to sustain, as the group continues to deliver the orderbook.

• Potential for lower interest costs. During its 1H24 results announcement, STE had noted that it estimates the 2024 weighted average borrowing costs at 3.7% (our estimate: 3.5%), assuming no US Federal Reserve rate cuts in 2024. Amidst our expectations of two rate cuts in 2H24, and additional rate cuts in 2025, we see a possibility of lower interest costs in 2025 (not in our estimates yet), which could further boost earnings. This is because 39% of STE’s debt remains exposed to a floating interest rate.

• High orderbook and strong visibility to 2H24 revenue. STE reported a record order backlog of SGD27.9bn as at end June, implying a book-to-bill ratio of 2.8 years. It estimates SGD4.9bn of the orders will be delivered in 2H24, which accounts for c.90% of our 2H24 revenue estimate.

• ESG premium. We continue to derive our TP using an average of P/E, P/BV, EV/EBITDA, and DCF. Our TP includes a 4% ESG premium over the fair value of SGD5.11, given its 3.3 ESG score vs 3.1 country median.

Source: RHB Research - 18 Sep 2024