• ST Engineering (SGX:S63) should deliver defensive growth, aided by a revival in global aviation traffic, gains from growing demand for smart-city solutions, and rising global defence spending. While 1H22 core earnings were below expectations, its strong order wins and record-high orderbook should keep investors interested.
• While recent M&A increased ST Engineering's operating costs and debt burden, we believe the acquired businesses will support medium-term profit growth. We expect 8% core profit CAGR in 2021-2024F.

ST Engineering's 1H22 Core Profit Was Below Expectations

• While profit of S$280m accounted for 46% of our estimates, it included a pre-tax one-off pension restructuring gain of S$72m. Core net profit of S$226m (-18% h-o-h, - 24% y-o-y) accounted for 37% of our estimates.
• Commercial Aerospace (CA) continued to register revenue growth (+24% y-o-y) in 1H22, aided by increased MRO services and nacelle deliveries. ST Engineering shared that while airframe MRO hangars are full, engine and component MRO business should continue to recover in 2H22.
• The key margin disappointment came from the Urban Solutions & Satcom (USS) segment, which reported EBIT loss amidst transaction and integration costs for TransCore and impact from chip shortages.
• ST Engineering announced an interim dividend of 4 cents.

Strong Order Wins and Record Orderbook

• ST Engineering won new contracts of S$3.1bn in 2Q22 (+69% y-o-y, +28% q-o-q). Strong order wins were reported by its Defence & Public Security (DPS) and CA businesses.
• ST Engineering reported its highest order backlog of S$22.2bn, which implies a book-to-bill ratio of 2.7 years – S$4.6bn of this order book is expected to be delivered in 2H22, representing 100% of our 2H22 revenue estimates.

Higher Near-term Costs From TransCore Acquisition

• Urban Solutions & Satcom (USS) segment revenue increased S$757m (+14% h-o-h, +43% y-o-y) aided by contribution from the TransCore acquisition and higher smart city deliveries. However, the business registered an EBIT loss amidst:
  • TransCore transaction and integration expenses of S$21m,
  • lower government support of S$3m and
  • weaker performance of Satcom, caused by semiconductor chip shortages.
• TransCore is expected to keep operating costs elevated (annual integration costs of S$10m) as well as the debt burden (additional S$700m of borrowings). We believe TransCore will also support ST Engineering’s medium-term profit growth in the USS business.

Adjusting Earnings Forecast for ST Engineering

• We lower 2022F core net profit forecast for ST Engineering by 9% to account for the one-off gain and 2023F-2024F profit by 1% and 2%.

• Our target price for ST Engineering is derived by using an average of P/E, P/BV, EV/EBITDA and DCF of FCF. Our target price includes an ESG premium of 8% over the fair value of S$4.26.
• Maintain BUY recommendation on ST Engineering with new S$4.60 target price from S$4.80, 13% upside, 4% yield.

Source: RHB Invest Research - 15 Aug 2022