BUY, SGD4.45 Target Price, 5% Upside and 4% FY20F Yield

• On an uncertain macroeconomic outlook, ST ENGINEERING (SGX:S63)’s double-digit profit CAGR outlook, diversified business, record-high orderbook with two years of revenue visibility, positive FCF generation capability, and relatively high dividend yield has led to it outperforming the STI by 12% YTD. See ST Engineering's share price performance.
• ST Engineering remains our country Top Pick, as we expect the stock to keep getting re-rated amidst completion of acquisitions and continuing order wins.

Building Long-term Aerospace Capabilities

• ST ENGINEERING (SGX:S63), which recently retained its position as the leading global airframe MRO service provider, continues to build capabilities in this business.
• In the last one month, ST Engineering has set up a JV company with Vietnam Airlines to provide component MRO services in Vietnam, signed a long-term collaboration agreement with Honeywell to act as a licensed repair centre for Honeywell components, collaborated with Air New Zealand to trial the use of drones to inspect aircraft undergoing maintenance checks at ST Engineering’s Changi Airport facility, and secured a letter of intent for delivering A321 converted freighters to BBAM, a global leader in aircraft lease management, by 2020.

Making Progress on Smart Nation Initiatives

• In the last, ST Engineering has entered into a partnership agreement with Nokia to technology and connectivity on key technology such 5G and Internet Things, signed a MoU with Singapore’s National Water Agency to and digital that will the latter’s intelligent management and, and demonstrated its Smart Honolulu, US.

Contributions From Acquisitions a Key Earnings Growth Catalyst

• The River Systems (MRAS), completed in Apr 2019, is expected to be-accretive from onwards. ST Engineering also remains confident of completing the Newtec acquisition by 2H19. We expect the latter to start contributing to earnings growth from FY20.

Recent Decline in Risk-free Rate Offers Upside to Target Price

• We value ST Engineering on blended valuations, ie FY20F 20.5x P/E, 5.5x P/BV, and 11x EV/EBITDA, as well as DCF (WACC: 6.8%, LTG:1.5%). The WACC is based on a risk-free rate of 2.5%. We use the Monetary Authority of Singapore 10-year (MASB10Y) bond yield as a proxy for the risk-free rate. Using a rate of 2%, which is where the MASB10Y is currently trading, will imply a DCF value of SGD5.40 and increases our Target Price to SGD4.60, offering 8.5% upside from current levels.
• Key downside risks are a slowdown in the aviation industry leading to weakness in aviation MRO demand, and delays in Smart Nation initiatives amidst decelerating global economic growth.
• Below-expectation contributions from MRAS and Newtec acquisitions could also derail earnings growth.

Source: RHB Invest Research - 5 Jul 2019