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Most analysts call ‘buy’ on ST Engineering, but Citi calls ‘sell’

·6-min read

Find out why Citi handed a "sell" rating to STE when others were calling "buy"

Analysts from five brokerages have mostly given “buy” calls on Singapore Technologies Engineering (ST Engineering) after its 1HFY2022 results were released, except for one.

DBS Group Research, RHB Group Research, Maybank Securities, and CGS-CIMB Research have all maintained their “buy” calls, but Citibank has broken from the consensus to hand the stock a “sell” rating and target price of $3.49.

Citi analyst Jamie Osman says he reiterates his “cautious view” on ST Engineering, as he continues to see structural challenges to its core demand for its maintenance, repair and operations (MRO) segments ahead, while efforts to pivot to passenger to freighter (PTF) aircraft conversions face headwinds like cost inflation and skilled labour shortages.

Furthermore, Osman thinks that persistent supply chain and component shortages pose risks to the recovery of its urban solutions and satcom segment (USS), including at its recently acquired TransCore business.

He also sees integration risks from recent acquisitions, including elevated gearing levels amid the rising interest-rate environment.

USS was negatively impacted by slower satcom demand recovery, chip shortage issues, and integration and transaction costs from the acquisition of TransCore.

Osman does say, however, that despite management flagging integration costs of $10 million - $20 million per year over the next few years for TransCore, it remains optimistic that cross-selling opportunities, as well as integration with its Smart City solutions, could be quickly achieved.

Meanwhile, he says the other positives that have been noted, like a robust order book and aviation MRO recovery, appear priced in, “considering its valuations of a FY2023 P/E ratio of 21x against his earnings per share (EPS) compound annual growth rate (CAGR) forecast of 5% over FY2021-FY2024.

“Notably, gearing levels have risen higher than we initially expected post-acquisition,” he says, noting ST Engineering’s net debt to equity ratio reached 2.4x as at end-1HFY2022, compared to  0.5x as at end-FY2021.

This is in light of ST Engineering’s management sharing that its first year financing costs have risen to 2.2%, and is currently exploring refinancing options for its US$1.7 billion ($2.33 billion) US commercial paper, which would impact interest costs from FY2023.

Osman concludes, “We believe positive narratives (strong order book, defensive business, air travel recovery) appear priced-in, while we remain cautious over potential industry headwinds, as well as integration risks from recent acquisitions.”

DBS: Growth trajectory becoming exciting

As for DBS analysts Survo Sarkar and Jason Sum, they have retained their target price of $4.70 in addition to their “buy” call as they see ST Engineering’s growth trajectory becoming “exciting”.

The analysts are expecting a CAGR close to 10% in net profit over FY2021-FY2023, driven by inorganic growth (TransCore) and recovery in the commercial aerospace segment.

However, the big story is that, instead of revenue stagnation (between FY2012-FY2018), growth momentum will continue, built on a solid foundation established since 2018.

With continued investments in research and development (R&D) and strategic acquisitions, ST Engineering remains well on top of crucial global needs of digitalisation, urbanisation, sustainability, and security, driving robust organic growth across segments of 4%-5% even out to 2026.

Key to this will be the strong ramp-up in passenger to freighter (P2F) conversions, and continued traction in the smart city space.

They highlight that ST Engineering offers a “decent yield” of [around] 4% as well as potential to deliver stronger growth.

That said, Sarkar and Sum acknowledge that they are more bullish on ST Engineering’s FY2023 earnings compared to their peers due to their concerns on the pace of aerospace recovery. The DBS analysts are, however, more bullish on the group’s recovery thereafter.

CGS-CIMB: Earnings have bottomed out

CGS-CIMB analysts Lim Siew Kee and Kenneth Tan have lowered their target price on ST Engineering to $4.53 from $4.58, saying that ST Engineering’s core net profit came below their expectations.

“Excluding one-off pension restructuring gain of $72 million, core net profit of $208 million was below our expectations and formed 36% of both our and Bloomberg consensus’ full-year forecasts.”

While the analysts acknowledge that this was due to weaker USS margins, margins in the commercial aerospace segment surprised them positively.

The group’s defence and commercial aerospace (CA) segment continued to recover in 1HFY2022, with revenue growth of 24% y-o-y driven by increased MRO services and more nacelle deliveries.

Even after stripping one-off gains, 1HFY2022 EBIT margin for the CA segment was “decent” at 7.9%.

Moving forward, Lim and Tan note that ST Engineering’s order book is at a new high of $22.2 billion as of end June, of which $4.6billion is expected to be delivered in 2HFY2022.

Separately, they note that defence remains a core pillar, with all defence sub-segments recording y-o-y revenue growth, except for marine, which dropped 9% h-o-h and 1% y-o-y with the decline due to weaker shipbuilding demand.

The huge order book and rising global tensions should continue to support the segment’s growth.

RHB: Stock to “deliver defensive growth”

RHB analyst Shekar Jasiwal has also reduced his target price to $4.60 from $4.80, saying 1HFY2022 core profit was below expectations.

Nonetheless, he says that ST Engineering 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.”

He thinks its strong order wins and a record-high order book should keep investors interested in the company, and while recent mergers and acquisitions (M&As) have increased its operating costs and debt burden, they believe the acquired businesses will support medium-term profit growth. Jasiwal expects a 8% core profit CAGR from 2021-2024.

Most specifically, he points out that there are higher near-term costs from the TransCore acquisition.

TransCore is expected to keep operating costs elevated, bearing an annual integration cost of $10 million, as well as a debt burden of an additional $700 million of borrowings. Nonetheless, he believes TransCore will also support ST Engineering’s medium-term profit growth in the USS business.

Maybank is expecting ST Engineering to report sequential recovery

Finally, Maybank’s Kelvin Tan also trims his target price from $4.75 to $4.50, expecting near term cost pressures to drag on the company’s balance sheet.

Tan trims his FY2022-FY2024 earnings forecast by 5%-6% to factor in TransCore acquisition expenses and rising cost pressures, but he does expect sequential earnings recovery from the USS segment in 2HFY2022 as the bulk of transaction expenses were booked in 1HFY2022.

“We expect 2HFY2022 to be better with greater contribution from TransCore and gradual aviation recovery,” he adds

He remains optimistic on ST Engineering’s growth prospects given a continual recovery in its aerospace segment, a strong contribution from TransCore acquisition, and a robust order book, which provides a healthy revenue visibility for the next few years.

However, he also cautions that short-term margins could continue to be hurt by rising opex and front-loaded acquisition expenses, coupled with lingering uncertainty over the global chip shortage.

As of 1.10pm, shares of ST Engineering were trading at $3.97, with an FY2022 P/B ratio of 4.6 and dividend yield of 3.7%, according to Maybank.

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