• Keep BUY and SGD4.60 TP, 25% upside and 4.7% yield. The share price has been underperforming on concerns over potential unexciting 2H22 earnings amidst a weakening macro environment and sharp rise in debt, especially in a rising interest rate environment. We stay confident of ST Engineering’s defensive characteristics that remain supported by a record-high orderbook, growing defence revenue, and Urban Solutions & Satcom Security’s potentially sharp recovery. We expect the DPS of 16 cents to stay steady and forecast an 8% core profit CAGR in 2021-2024.

• Nok Air maintenance contract renewal. The commercial aerospace business has secured a 5-year component maintenance-by-the-hour (MBH) contract to service Thai budget carrier Nok Air’s Boeing 737-800 fleet. Under the multi-year component MBH contract, STE will provide a full suite of component support solutions covering component repair management, pool support, and dedicated consignment stock in Bangkok for the airline’s entire 737-800 fleet. The contract is a renewal of the partnership in component MRO between Nok Air and STE. This will further strengthen its commercial aerospace orderbook, in our view, which has reported an average of SGD930m in order wins each quarter since 1Q21.

• Key concerns. Based on our recent discussions with some investors, it seems the disappointment around the recent bottomline miss during 1H22 and potential for another miss for 2H22 earnings amidst a weakening macroeconomic environment remains the one of the key concerns. In addition, the rise in STE’s debt levels to fund the TransCore acquisition, especially in a rising interest rate environment, is also getting identified as a concern. On the back of higher earnings and improvement in cash flows, we expect STE’s net debt to equity to gradually improve over the forecast period, but estimate it to remain above 1.5x in 2024.

• Outlook beyond 2022 still solid. We expect STE’s strong orderbook to support earnings growth beyond 2022 and estimate its 2023-2024 profit growth at 13-17%. We expect strong recovery in its Urban Solutions & Satcom Security or USS unit along with a sustained improvement in the Defence & Public Security wing to drive 2023-2024 earnings growth. With SGD3.1bn worth of new contracts in 2Q22 (+69% YoY, +28% QoQ), STE reported its highest order backlog of SGD22.2bn, which implies a book-tobill ratio of 2.7 years – SGD4.6bn of this orderbook is expected to be delivered in 2H22, representing 100% of our 2H22 revenue estimates.

• We assess STE to deserve an ESG premium. We continue to derive our TP by using an average of P/E, P/BV, EV/EBITDA, and DCF of FCF. Given our internally assessed ESG rating of 3.40 is higher than the country median of 3.00, we include an ESG premium of 8% over the fair value of SGD4.25 in our TP.

Source: RHB Research - 23 Sept 2022