Recent De-rating Unwarranted; Upgrade to BUY

• We met with ST Engineering (SGX:S63) for an update; Its various strategic and growth initiatives appear to be on track, which would suggest the 9% share price decline the past quarter is unwarranted.
• Additionally, its long term capital structure will likely have a higher level of gearing than we expected which drives down our WACC assumption and increases our Target Price increase to SGD4.50 from SGD4.30.
• With 17% upside to our revised target price and 17% return potential, we upgrade rating to BUY from HOLD.

Tracking Its Strategic Growth Plan

• Two of the three announced acquisitions of the past year have been concluded (MRAS, Glowlink), while Newtec is expected to close by end- 2019. A substantial part of the strategic review that started early-2018 is done and divestment of unprofitable businesses has led to a more streamlined ~140 operating units vs. 168 at the beginning of the process.
• Meanwhile, the current trade tensions may actually be a mild positive for ST Engineering with the private sector in some countries now more hesitant to consider Chinese technology solutions providers for the long term.
• See attached PDF report for detailed recap on ST Engineering's strategic growth plan and the scorecard so far.

More M&A or Dividends (or Both) Could Surprise

• ST Engineering has seen a sharp rise in gearing in the past few quarters post the recent sizeable investments. The company indicated it was comfortable with maintaining gearing at current levels (net debt/equity at c55% as of end 2Q19) as management are keen to improve balance sheet efficiency. This is a much higher gearing level than our earlier assumption of a long term net debt/equity structure of 25%.
• Given regular annual capex of SGD300-350m, our operating cashflow growth forecasts suggest two likely outcomes for current gearing levels to be maintained over the long run:
  1. more sizeable acquisitions in the pipeline; and/or
  2. higher dividends than the fixed 15cts/sh ST Engineering has paid out for the past six years.
• See attached PDF report for summary of ST Engineering's M&A transaction value in the past decade.

A Lower WACC Drives Our Target Price Increase

• Our post-meeting PATMI forecasts are unchanged. But ST Engineering’s stated objective on sweating its balance sheet harder had us revisit our earlier DCF assumptions to factor in higher net gearing levels. The resultant c30bps lower WACC drives our 5% Target Price increase to SGD4.50.
• Upgrade to BUY.

Source: Maybank Kim Eng Research - 8 Oct 2019