• In its 1Q20 business update, ST Engineering (SGX:S63) guided for 5- 15% decline in 2020 revenue. It should deliver a profit and positive FCF in 2020 with earnings supported by defence business.
• Earnings growth will likely resume in 2021 as the global aviation industry gradually recovers.
• Keep BUY with new SGD3.90 Target Price from SGD4.15 Target Price, 19% upside and 5% yield.
• ST Engineering, a country Top Pick, should continue to outperform the STI, given its well-diversified business portfolio, record-high orderbook and sustainable DPS payout.

ST Engineering's 1Q20 Business Update

• ST Engineering noted that the COVID-19 pandemic has reduced customer demand, caused supply chain disruptions, and led to workforce disruptions. Its Electronics business has witnessed delays in delivery schedules while there was reduced demand for its Satcom business.
• For Aerospace, MRO capacity utilisation declined to 80-85% in 1Q20. This is expected to drop to 60%-65% in the coming quarters.
• Production of aircraft engine nacelle components at Middle River Aerostructure Systems has declined, while passenger to freighter conversions are impacted by supply chain disruptions.

Cost Reduction and Government Support

• ST Engineering is undertaking a group wide cost reduction initiative, especially for businesses that will see long-term revenue impact from COVID-19. In addition to pay cuts undertaken by its management and directors, government support of SGD100m should enable the company in keeping costs in check during 2020.

Defence to Support 2020 Earnings

• Given its long gestation period, the defence business, which spreads across all segments, is expected to remain steady in 2020. Defence accounts for 30-35% of revenue. The company will ramp up the supply of the Hunter Armoured Fighting Vehicle (HAV) under Phase 1 of the contract from Singapore’s Ministry of Defence by mid-2020.
• While the Phase 1 contract is expected to last for 2-3 years, ST Engineering has already secured the Phase 2 contract for HAV. Management guided that supply of HAV is a material contract.

Strong Revenue Visibility

• ST Engineering reported its highest ever orderbook of SGD16.3bn, which offers > 2 years of revenue visibility. Of this orderbook, SGD4.5bn worth of orders are expected to be recognised in 9M20.

Earnings Recovery in 2021 and Resilient Yield Play

• Although we lower 2020F-2022F earnings by 10-12%, ST Engineering should see a return to earnings growth in 2021 amidst gradual recovery of domestic aviation traffic in the US and China and normalisation of supply chain and delivery schedules for most businesses segments.
• Given its strong FCF generation, we expect it to maintain unchanged DPS payout of 15 SG cents in 2020, or 4.6% yield.

Source: RHB Invest Research - 18 May 2020