• ST Engineering plans to make up for the absence of an S$250m grant in FY21F via S$180m cost reduction and S$70m modest recovery and less impairment.
• The outlook for Aero PTF is strong, driven by airfreight market buffering weak aircraft MRO. Electronics and Land systems are backed by order execution.
• ST Engineering's FY20 results were in line and relatively better vs conglomerate peers with modest impairment. Dividend firm y-o-y at S$0.15 per share and likely to remain in FY21F.

Confident of Closing the Government Grant Gap

• ST Engineering (SGX:S63)’s 2H20 net profit of S$264m was in line and formed 51% of our FY20 forecast and consensus, helped by tax credit. FY20 net profit of S$521m also included S$54m impairments & fair value changes of associates and provision made for onerous contracts.
• ST Engineering's FY20 net profit was in line at ~101% of our full-year forecast. ST Engineering received a total of S$350m government grant in FY20 and expects to receive ~S$100m in FY21F (including the latest round of handouts from the Singapore government which were announced in the Feb 21 Budget).
• Management was confident in the earnings call that the shortfall of S$250m can be met by efforts put in since 2020, i.e. reducing remuneration for sub-contractors, contract staff and overtime.

Aerospace Sector's Outlook Lifted by PTF as Slots Are Booked Till 2022

• The demand for Passenger to Freighter (PTF) conversion is strong as ST Engineering inducted 10 aircraft in 2020 and will induct more than 30 aircraft in 2021 and 40 in 2022. Aero has four PTF conversion lines and is increasing this to eight lines by end-FY21 to meet the rising demand.
• Conversion of aircraft takes about 3-12 months, depending on the model and learning curve. The conversion slots are fully booked till end-22 with new slots opening for 2023. We expect Aerospace sector profit to decline 5% y-o-y in FY21F to factor in fewer nacelle deliveries and slow recovery in aviation travel.
• Aerospace sector secured S$821m worth of new contracts in 4Q20. It is on the lookout for new growth opportunities including engine/aircraft leasing to enhance recurring income.
• Aerospace sector’s 2H20 net profit of S$87.9m (- 16% h-o-h, -38% y-o-y) was below expectations due to impairment of assets which led to a loss of S$1.5m in Engineering & Material Services (EMS). Aircraft Maintenance & Modification’s (AMM) net profit of S$60m (+44% h-o-h, +67% y-o-y) could have been boosted by government relief.

Electronics Sector Is COVID-proof

• Electronics sector secured S$516m worth of contracts in 4Q20, bringing the FY20 total to S$2.9bn, similar to FY19’s.
• Electronics sector is in a sweet spot with secular demand for Internet of Things (IoT) solutions, cyber security and AI capabilities along with outsourcing by government agencies. We forecast Electronics sector’s net profit to rise 3% y-o-y to S$210 in FY21F on the back of more than S$2bn annual order wins.
• Electronics sector’s 2H20 net profit of S$116m (+33% h-o-h, +14% y-o-y) beat expectations mainly due to the iDirect US profits that were significantly impacted by COVID-19 in 1H20.

Land Systems Sector Already in EV (bus)

• Land systems sector’s 2H20 net profit of S$116m (+43% h-o-h, +43% y-o-y) was in line with expectations, boosted by stronger service trading and munition & weapon as well as government grant.
• We forecast the division to achieve 13% y-o-y net profit growth in FY21F, driven by more deliveries of Hunter Armoured Fighting Vehicle for Singapore Ministry of Defence for the next 2-3 years.
• Land systems will also progressively deliver the 3-door double decker buses and electric buses to Singapore’s Land Transport Authority (LTA). ST Engineering was awarded the contract to provide 20 electric buses in 2018, joining the fleet of 60 electric buses. The Singapore government aims to phase out diesel buses (5,800 units) by 2040.

Marine Sector Watchful on Costs

• Marine sector’s 2H20 net profit of S$6.9m (-68% h-o-h, -73% y-o-y) was a miss mainly due to cost overruns in the repair of Q-LNG Bunkering Articulated Tug Barge contracts in its US yard. The contracts were clinched in 2017 at low pricing and have encountered Cutter for the US Navy which is scheduled for delivery in 2024.

Reiterate ADD With a Target Price of S$4.00, Strong ROE of 22%

• We keep our target price for ST Engineering, still based on blended valuations (DCF, 19x CY22 P/E and 4% yield).
• We cut our ST Engineering's FY21F-22F earnings per share forecast by 8-13% to account for MRO for Aerospace sector. We have assumed dividend of S$0.15 per share in FY21F, yielding 4%.
• Relative to its peers in the industrial/conglomerate space, ST Engineering has fared better in FY20 earnings although largely helped by the grant. We like the diversification of the group, disciplined cost management and strong ROE.
• Catalysts: defence contracts and lifting of travel border restrictions.
• Risk: significant cost overrun and new pandemic.

Source: CGS-CIMB Research - 19 Feb 2021