• ST Engineering expects partial recovery across its sectors (except aero) and aggressive cost reduction to plug the > S$300m gap in government grant in FY21F.
• 1H20 net profit in line, and relatively better vs. conglomerate peers. Steady 1H DPS of S$0.05 a precursor to S$0.13-0.15 FY20F DPS (c.4% yield).
• Reiterate ADD with higher Target Price of S$3.66, still based on blended valuations (4% yield, 20x FY20F P/E, DCF).
• Catalyst: stronger defence contract wins.

In-line 1H20 Results, Revenue Slight Beat

• ST Engineering (SGX:S63)'s 1H20 net profit of S$257m (-4% y-o-y) was in line with our and consensus estimates, at 51% of our FY20F. Interim DPS of S$0.05 (unchanged y-o-y) is a good sign as Singpore corporates have cut dividend.
• We lift FY20F DPS to S$0.15 (from S$0.13). ST Engineering expects S$300m of government grants in FY20F; less than 50% was received in 1H20.
• For Singapore, ST Engineering has accrued 50% of the 10-month Job Support Scheme (JSS) grant in 1H20; 40% were for aerospace. JSS grant is unlikely in FY20F but we do not rule out more targeted government help for weaker sectors (marine, aerospace). 1H20 revenue of S$3.5bn (+2% y-o-y) was deem a slight beat forming 54% of our FY20F.

Aero: 3 Years to Pre-Covid Levels, PTF Helps, Airframe MRO Not as Bad

• Not surprisingly, the value of new contracts secured dropped 33% to S$1.4bn in 1H20. 1H20 overall average capacity was at 2/3 vs. 100% at the start of 2020. 1H20 aero net profit of S$105m (-17% y-o-y) was in line. Airframe revenue declined 2% y-o-y in 1H20 to S$474m, commendable given the COVID-19 outbreak, as aircraft in service still required maintenance, repair and overhaul (MRO).
• Component and engines revenues were more affected as airlines conserve cash and activate parked fleet’s engine/components to those aircraft in service, and delay engine shop visits. ST Engineering sees 3-4 years for aero revenues to return to pre-Covid levels. However, strong demand (rising interests from customers) for cargo aircraft and its passenger-to-freighter (PTF) programme could buffer this.
• We believe PTF could be prominent in FY21F as aircraft feedstock and supply chain problems are gradually resolved. MRAS's reduced nacelle production capacity in 1H20 tracks Airbus guidance of 40 units/mth for A320 neo.

Land Systems: Profit Up 77% Y-o-y, Expect a Stronger 2H20F

• Land System’s 1H20 net profit grew 77% y-o-y to S$41.8m, thanks to delivery of Hunter and stronger weapon and ammunition profit but delayed slightly due to the two months of circuit breaker in Singapore. We expect stronger 2H20F earnings from the division as Hunter has reached optimal production capacity by Jun with more deliveries expected.

Marine: Revenue Strengthened, But Hit by Cost Overrun

• Marine's 1H20 net profit of S$21.6m (-19% y-o-y) was below our S$27m expectation due to cost overruns incurred for its US projects (Auxiliary Personnel Lighter Small APL Class Berthing Barges) as contracts were bided at trough pricing to keep its yard utilisation going.
• The outbreak of COVID-19 delayed the completion progress and caused supply chain disruptions which it was not able to be passed on to customers. This resulted in a loss of S$6.3m in shipbuilding. Excluding the above, ST Engineering's marine shipbuilding revenues were up 125% y-o-y in 1H20, thanks to its US yards.
• Ship repair revenue was also relatively flat (-5% y-o-y) with strong activities in Singapore yards in 1Q. Rig repairs in the US yards were less affected by the restrictions in movement. We believe defence jobs in Singapore helped boosted topline growth in 1H20.

Electronics Still Seeing Order Wins

• Electronics 1H20 net profit of S$87.6m (flat y-o-y) was above our S$78m forecast, as stronger revenues were recorded across segments, especially for large-scale systems (+2% y-o-y) with execution of previously-secured contracts. Communication & Sensor Systems revenue were flattish y-o-y due to the consolidation of Newtec but profit declined 86% y-o-y to S$3.5m due to Newtec integration costs as well as weaker margin from iDirect US given the currently challenging satellite communication industry.
• Electronics order win value declined 14% y-o-y to S$1.3bn in 1H20 due to delays in the tenders, especially for Internet of Things (IoT) projects, and the order outlook for this segment could remain challenging. However, defence-related contract wins remain good and existing projects continue to be executed on track.

Order Book of S$15.9bn; Maintain ADD With Higher Target Price of S$3.76

• We raise ST Engineering's FY20-22F EPS by 1.7-7.8% and our Target Price to S$3.76.
• ST Engineering’s FY20F S$6.7bn-7.5bn revenue guidance appears conservative as it has S$3.2bn in its order book to be recognised in 2H20F. Non-order book revenue accounted for 13- 35% of 2H revenues in the past three years. Hence, FY20F revenue is likely to be flattish, in our view.

Source: CGS-CIMB Research - 14 Aug 2020