Outlook Positive Despite the Softer 4Q/FY18

• SINGAPORE TECH ENGINEERING LTD (SGX:S63, ST Engineering)'s 4Q18/FY18 reported profit fell 26%/3% y-o-y and was below our and consensus expectation due to a number of one-offs. Underlying core profit was softer than expected too but only slightly with 4Q18/FY18 growing 7%/9%.
• We cut FY19F/20F/21F PATMI by 9%/2%/1% mainly from delays in the MRAS acquisition integration from factors outside of ST Engineering’s control.
• Our Target Price has been cut 2.3% to SGD4.25 (DCF at WACC 8.1%, TGR 2% unchanged).
• We remain positive on the growth fundamentals of ST Engineering. Maintain BUY.

Portfolio Rationalisation in Progress

• 4Q18/FY18 was peppered with one-off items, most of them to do with ST Engineering’s periodic business portfolio evaluation and rationalisation. These included divestment losses from closure of a pilot training school in the US and a road construction entity in India, full impairment of auto MRO and road construction businesses in Brazil and an SG&A increase for transaction costs (advisory and legal fees) related to its pending acquisition of MRAS.
• Also recall the FY18 net finance charges spike is from the early redemption of a SGD500m MTN facility, which is subsequently expected to result in some SGD33m in interest cost savings over 12 months.

Underlying Business Ticking Along

• By our estimate, excluding one-off items and charges, revenue, EBIT and net profit for 4Q18 would have been up 4%/9%/7% y-o-y and for FY18, up 1%/11%/9%; slightly lower than our estimates.
• A relatively small area of the business that continues to be a drag is its US computer hardware subsidiary VT Miltope.
• The project pipeline and outlook for FY19 for Aerospace, Electronics and Land Systems remains positive. The Marine segment outlook is muted due to the industry slump; that said, segment pre-tax profit has been growing sequentially for four quarters indicating that cost control and right-sizing measures are bearing fruit.

Continuing to Invest; MRAS to See Delays

• The recent material investments in a new aerospace facility in Pensacola, USA with UPS as the launch customer and a second panel manufacturing plant in Germany for key customer Airbus are on track. However, integration of the MRAS acquisition will likely see some delays resulting from the long US government shutdown last quarter.

4Q/FY18 Results Highlights 

• ST Engineering's reported 4Q18 PATMI down 26% y-o-y and 8% q-o-q due to the various one-off costs and charges described. Excluding these one-offs, core PATMI would have grown 7% y-o-y and 13% q-o-q. For full year FY18 PATMI fell 3% y-o-y but would have grown 9% excluding one-offs.
• Net order book stood at SGD13.2b, a shade below its all-time high of SGD13.4b; around SGD4.9b of this is expected to be realised during FY19.
• The recent 2019 Singapore Budget announcement could be a potential positive for ST Engineering given the focus on defence, cyber security and technology upgrade spend.
• Management indicated ST Engineering is already in line with the tightened DRC targets for foreign labour (relevant mainly for the Marine segment).
• FY18 dividend payout was 15 cents/share (interim 5 cents and final 10 cents), unchanged y-o-y. This translated to 95% pay-out of reported PATMI (or c88% of estimated core PATMI).

Forecast and Valuation Changes

• We have cut our FY19F/FY20F/FY21F PATMI forecasts by 9%/2%/1%. The lion’s share of the downward revision to our expectations is to do with the delays in integration of the MRAS acquisition which we had earlier assumed would start contributing from early FY19F. The delays faced in closing this transaction are primarily to do with the unforeseen US Government shutdown for some 40 days during 4Q18.
• Management indicate that most of the various approvals required to close the transaction (including key anti-trust approvals) have since been obtained and ST Engineering hopes to complete the deal by end-1Q19. We have conservatively changed our assumption for MRAS contribution to the group to not commence until 2H19.
• Other minor changes to our forecasts are to do with a slightly lower than expected revenue for the Others segment (primarily VT Miltope which makes ruggedised computers for military applications) and working capital, net debt balance and MRAS integration cost related adjustments in light of the FY18 full-year accounts.
• On the back of PATMI forecast revisions, we cut DCF-based (WACC, TGR assumptions unchanged) TP 2.3% to SGD4.25 from SGD4.35. The revised Target Price equates to 20x FY19 P/E, at a modest 7% premium above ST Engineering’s 10-year forward P/E mean.

Source: Maybank Kim Eng Research - 22 Feb 2019