• We believe ST Engineering could outperform its industrial peers in the upcoming 3Q19 earnings season, with 9% q-o-q and 12% y-o-y profit growth to S$151m.
• We gleaned from ST Engineering’s teach-in that satcom industry demand grows by a 10-15% CAGR p.a. We expect similar growth for ST Engineering’s satcom profit.
• We like the satcom business which is scalable, its 70-80% market share in broadcast and aviation sectors and customers are locked in for the long-term.

What Satcoms Do ST Engineering Sell?

• Simply put, ST Engineering (SGX:S63) manufactures the ground equipment segment (routers, modem hubs, antennas, etc.) as well as provides system integration services (with maintenance support of 8-12% of equipment costs). Combining both of its satcom subsidiaries, iDirect and the recently acquired Newtec, ST Engineering commands about 70-80% of market share in the aviation and broadcast industry and 18% of enterprise (e.g. banks, telco, retail) globally.
• Enterprise formed the largest portion of its modems revenue and is expected to grow by 8-9% p.a. vs. aviation at 15-20% p.a. and broadcast at 3-5% p.a.
• We estimate ST Engineering’s satcom contributed about 12% of its PBT and average growth of 10% p.a., represented mainly by iDirect in CSG.
• Management guided that the Newtec acquisition could add south of S$10m net profit in FY20F and north of S$10m thereafter, with some integration costs in 4Q19.

Locking in Customers on High Switching Costs

• We like ST Engineering’s modular hub business model which is scalable. Customers are able to set up the initial satcom network with a few remotes/routers and gradually scale up to hubs and complex networks, locking in customers in the long-term. Switching costs are typically high for customers to change the end-to-end satellite connectivity infrastructure.
• Some of the notable customers include Inmarsat, Qatar Airways Verizon, Walmart, SingTel (SGX:Z74), Arab Satellite Communications, Marlink and Speedcast.

Demand Drivers

• Demand for satcom systems is backed by
  1. emergence of Low Earth Orbit (LEO) constellations, lower costs per bit that increase demand for small and low-cost integrated terminals,
  2. more complex networks as satcom and 5G converge and
  3. increased risk of satellite interference.
• ST Engineering has over the years built up its satcom capabilities via milestone acquisitions such as iDirect (satcom products) in 2005, Parallel Limited (VSAT system) in 2010, Jettalk (revolutionary flat panel antenna for the aviation industry) in 2019.

3Q19 Earnings Preview (results: 11 Nov 2019)

• We estimate the ST Engineering group could deliver 9% q-o-q and 12% y-o-y growth in profit (S$151m) for 3Q19.
• Aerospace will enjoy a full quarter earnings contribution from MRAS vs.1.5 months in 2Q19 (c.S$8m profit). Management expects MRAS to be earnings-accretive even with integration costs (we estimate S$3m-4m in 3Q19.
• Electronics are likely to retain its seasonally stronger 2Hs. However, there could be some decline y-o-y as CSG was stronger in 2Q19 due to the delivery of certain projects ahead of time.
• Land systems progressive delivery of Hunter Armoured Fighting Vehicle should sustain 20% y-o-y growth in profits.
• Marine will see improvement in shipbuilding as it executes contracts announced in 2018 (S$745m). Consistent strong quarterly contract wins are key catalysts.
• Maintain ADD and Target Price of S$4.36 on blended valuations.

Source: CGS-CIMB Research - 11 Oct 2019