• We like ST Engineering for its diversified business, even within Aero as when MRO work reduces, PTF work may back fill utilisation ahead. Maintain ADD with higher target price.
• ST Engineering 3Q20 order wins of S$1.7bn exceeded the group’s pre-Covid average of S$1.6bn in 2018-19. This excludes unannounced defence contracts.
• Cost cut to cover 50% of the global government relief tapering off from S$300m in 2020 to S$100m in 2021. Revenue recovery could help too.

Orders Exceeded Pre-Covid Average, No Compromise in Margin

• Electronics was ST Engineering (SGX:S63)'s best performing segment in 3Q20 as it secured S$1bn orders, while Aero brought in S$0.6bn of nacelle and floor panel manufacturing contracts. Management expects Elect order momentum to continue from strong governmental spending in technology, cloud and continuing urbanisation trend.
• There were other defence-related projects from marine and land systems which were unannounced due to sensitivity.
• Despite COVID-19, ST Engineering's order book remained steady y-o-y at S$15.8bn as of 3Q20. Management reaffirmed that margins were not compromised by the strong order intake.

Cost Optimisation and Revenue Recovery to Buffer Relief Decline

• ST Engineering expects to receive north of S$300m of government relief globally in 2020 and S$100m in 2021. ST Engineering expects cost-cutting measures and revenue recovery to offset the y-o-y relief decline. The full effect of cost savings is only visible by 2H21.
• ST Engineering also guided that its FY20F revenue will be close to the midpoint of the earlier guidance of 5- 15% lower than FY19F, in line with our expected -9% y-o-y.
• Unlike peers that had impaired some Maintenance Repair and Overhaul (MRO) assets due to challenging aviation operating environment, we believe ST Engineering is unlikely to see significant impairment thanks to the diversified portfolio and clientele including Passengers to Freighter (PTF) conversion, nacelle manufacturing, commercial and passenger aircraft. Its global footprint beyond Singapore (US and China) should also benefit from the pick-up in domestic air travel.

Rosy PTF Outlook, Expanding to More Than 25 Slots by 2023

• Limited aircraft belly load capacity has sustained demand for dedicated freighters. Fleet retirements also helped to feedstock availability. ST Engineering plans to expand its PTF slots of narrow body A321 from nine to more than 25 by 2023. Upfront PTF investment could be high and usually takes 12-18 months to reach optimal scale efficiency.

Reorganised for Global Growth, Reiterate ADD With Higher Target Price

• We roll forward our ST Engineering target price to CY22F, still based on blended valuations (DCF, 19x CY22 P/E and 4% yield).

ST Engineering's New Organisation Strucuture

• With effect from 1 Jan 2021, ST Engineering will be reorganised as Commercial and Defence & Public Security clusters, replacing the current Aerospace, Electronics, Land systems and Marine sector structure to better execute its global growth in smart city and international defence business. We think this could mean leaner structure and better operating leverage Management said that actual financial targets will be shared in 2021.
• We believe the reorganisation to streamline the group into two major segments could see positive cost sharing across divisions. This could reduce redundancy, forcing leaner operating leverage.
• Under the commercial segment, it includes three business units:-
  1. Commercial aerospace,
  2. Urban solutions,
  3. Satcom which is ST Engineering’s Global Business Areas (GBA) to drive long-term growth in the aerospace and smart city business.
• Defence and public security segment will house four business units:-
  1. Digital systems and Cyber,
  2. Land systems,
  3. Marine,
  4. Defence Aerospace which is ST Engineering’s Defence Business Areas (DBA) to focus on capturing growth across the international defence, public safety and security businesses.
• Together with ST Engineering’s Group Technology Office, the reorganisation will also allow ST Engineering to focus its technology and engineering core through its newly established Group Engineering Centre to drive advanced technology and engineering applications for the GBA and DBA. This allows ST Engineering to focus on initiatives such as Autonomous Systems-of-Systems, Cybersecurity, Smart Enterprise Platform and Smart MRO.
• As a result of the reorganisation, ST Engineering will adopt a new segmental reporting framework from FY21 which will be disclosed some time in Feb 2021 according to the management.

New executive structure to lead ST Engineering’s future.

• To lead the “new” organisation, ST Engineering will be led by the Group Executive Committee spearheaded by Mr Vincent Chong who is the President and CEO of the group and will be supported by an eight-member Group of Senior Business Council.
• Another notable change in leadership structure is the establishment of two Chief Operating Officer (COO) roles. Mr Lim Serh Ghee (COO, Operations Excellence) is responsible for Group IT, procurement and estate and facilities management while Mr Ravinder Singh (COO, Technology and Innovation) will be responsible for driving business innovation and developing best-in-class technologies across ST Engineering.

Source: CGS-CIMB Research - 18 Nov 2020