• Better than expected level of order wins in 3Q20, ST Engineering's orderbook healthy at S$15.8bn at end-3Q20.
• Promising developments on the vaccine front should accelerate core earnings recovery in FY21F.
• ST Engineering's new organisational structure should sharpen business focus, improve visibility and resonate better with investors.

ST Engineering's Order Backlog Remains Strong, Focus on Vaccine Hopes and Organisational Rejig in 2021

• ST Engineering (SGX:S63)'s order backlog healthy at S$15.8bn as at 3Q20, down marginally from S$15.9bn in 2Q20.
• ST Engineering announced impressive contract wins of S$1.7bn for the quarter, with a particularly strong showing for the electronics division, which clinched S$1.1bn worth of new orders, its best quarterly new order win performance on record.
• Management shared that while contracting momentum in the aerospace division remains sluggish, tendering activity for smart city projects continues to be strong, as governments are prioritising infrastructure spending to revive economic growth.

Narrowed Revenue Guidance Range in Line With Our Expectations

• The management also shared that they now expect the y-o-y decline in FY20F revenue to be closer to the midpoint of their earlier guidance of 5-15%, which is consistent with our existing estimate of a 10.6% revenue decline in FY20F.
• We expect ST Engineering's revenue to bounce back 16% in FY21F.

Cost-cutting Measures, Recovery in Demand, and New Business Opportunities to Offset Impact of Lower Government Grants in 2021

• ST Engineering indicated that around 50% of the impact of the lower quantum of government grants in FY21F will be moderated by its efficiency and productivity initiatives, with the remainder split evenly between a turnaround in demand, and new demand arising from COVID-19 fallout like Passenger-to-Freight (P2F) conversions and cybersecurity and sensors.

MRO Demand Should Have Bottomed; Vaccine Breakthrough Bolsters Visibility on Earnings Recovery

• ST Engineering shared that overall utilisation in its hangars in 3Q20 was stable at 66.0%, essentially flat q-o-q. Consistent with the global aircraft fleet mix (75% narrow-body and 25% wide-body), ST Engineering has high exposure to the narrow-body aftermarket, which is seeing decent traction due to a swift turnaround in domestic air traffic and robust freighter demand.
• Looking ahead, we believe that recent developments on the vaccine front could translate into a rebound in international travel activity by 2H2021F, which bodes well for MRO work volumes in 2021 – note that airlines have to perform bridging checks to ensure the airworthiness of parked planes before bringing them back into service. The workload is proportionate to the amount of time the aircraft is parked. In the meantime, P2F conversions should boost hangar utilisation.

Electronics Division’s Prospects Appear Brighter

• Electronics division’s prospects appear brighter, with most defence and government projects back on track after facing COVID-19 induced delays in the previous two quarters.
• Demand for satcom solutions will also benefit from the vaccine tailwind due to ST Engineering’s strong satcom presence in commercial aviation/cruise lines and sports events.

Organisational Structure Changes Should be Well Received by Shareholders

• ST Engineering plans on making organisational changes to position the Group towards its aspiration to become a global technology, defence and engineering powerhouse.
• Effective 1 January 2021, ST Engineering will be reorganised as Commercial (2/3 of revenue) and Defence & Public Security clusters (1/3 of revenue), replacing the sector-structure of Aerospace, Electronics, Land Systems and Marine.
  • The Commercial cluster will comprise Commercial Aerospace, Urban Solutions and Satellite Communications domains. So essentially, apart from the commercial MRO, the commercial Smart City solutions, which was spread across all sectors previously, will now come into one unit.
  • The Defence & Public Security cluster will comprise Digital Systems and Cyber, Land Systems, Marine and Defence Aerospace.
• While the group’s core strategy remains unchanged, we believe that this organisational rejig will resonate well with investors, as it
  • will better enable the group to execute their global growth strategy, and pursue smart city and international business opportunities, and
  • simplify the group’s reporting structure and help investors better understand the group.

Maintain BUY on ST Engineering With Higher Target Price on Higher Earnings

• We are raising our ST Engineering's FY21F earnings projections by 8% as we are pushing back some of the JSS grants recognition from FY20F to FY21F and taking into account potential vaccine tailwinds in 2H21F. Accordingly, we revise up our ST Engineering's target price to factor in the earnings upgrade for FY21F, as well as higher valuation pegs in line with improved market sentiments related to promising developments on COVID-19 vaccine front.

Source: DBS Research - 19 Nov 2020