SINGAPORE (Oct 9): Maybank Kim Eng Research is upgrading ST Engineering (STE) to a “buy” recommendation, from “hold” previously, and raising its target price by 4.7% to $4.50.
The technology, defence and engineering conglomerate has seen its share price slide more than 9% since closing at a multi-year peak of $4.32 at the end of July. But Maybank analyst Neel Sinha believes the recent de-rating has been “unwarranted”.
According to the analyst, the group’s various strategic and growth initiatives appear to be on track.
For a start, two of the three acquisitions that were announced by the group this year have been concluded. The acquisition of MRA Systems was completed in April, while the acquisition of Glowlink Communications was completed in September.
See: ST Engineering acquiring engine nacelle systems manufacturer from GE
In addition, the acquisition of Belgium-based satellite communications company Newtec is expected to be fully completed the end of the year.
See: ST Engineering boosts satcom anti-jamming capabilities with $28 mil acquisition
“Meaningful acquisitions have been made,” Sinha says. “MRAS allows STE to move up the value chain into aircraft component manufacture and will drive follow-though the maintenance, repair and operations (MRO) business of these components.”
“Newtec and Glowlink are important technology capability acquisitions to enable participation in Smart City solutions, 5G and growing connectivity of sectors, like aerospace and marine,” he adds.
Although STE has been known to be an acquisitive company over the past two decades, market watchers note that recent transactions have been sizeable and much larger than those witnessed in the most prior years. In the past 18 months alone, the group has announced acquisitions worth $1.1 billion.
Apart from new acquisitions, STE seems to be making a conscious effort to review and streamline its existing operations. A substantial review saw divestments of unprofitable businesses, resulting in a downsizing of operating units to 140 from 168 in early-2018.
Moving forward, Sinha notes that the group is likely to exit unprofitable units with no discernable competitive advantage and sub-scale, while profitable ones are also being evaluated on an ongoing basis for competitive advantages and technology gaps.
“The efficiency measures from higher business segment coordination and procurement [are likely to] to amount to a cumulative net saving of $150 million over five years and $50 million annually thereafter,” says Sinha.
In addition, STE has seen a sharp rise in gearing over the past few quarters following its recent sizeable investments. Compared to Maybank’s earlier assumption of a long term net debt/equity structure of 25%, the group’s gearing as of 2Q19 is indeed much higher at 55%.
The management had indicated that it was comfortable with maintaining gearing at that level as it works to improve balance sheet efficiency. However, Sinha opines that there are two likely outcomes for the gearing level to be maintained at that level over the long run with the regular annual capex of $300-350 million – more sizeable acquisitions in the pipeline, and dividends higher than the fixed 15 cents per share that STE has paid out for the past six years.
In fact, Sinha notes that higher dividends are a possibility due to profit growth on the back of recent mergers and acquisitions, as well as the higher pay-outs that could be prompted by a renewed focus on maintaining an efficient balance sheet
Moving forward, while Maybank cautions that it may still be too early to evaluate the progress in the marine division, STE’s order book and recent contracts position the group in a good place to ride the waves.
At the end of 1Q19, STE’s order book stood at a record-high of $14.1 billion.
“The $1 billion shipbuilding contract for a heavy icebreaker vessel from the US Navy in April 2019 is a material win. The contract comes with options for another two ships that could bring potential total contract value up to $2.6 billion,” says Sinha.
To top it all off, Sinha notes that STE has remained relatively unscathed from the US-China trade tensions that have adversely impacted companies across all industries in one way or another.
“STE has not seen any disruption to its businesses so far, barring some minor delays in capex approvals with its customers. If the tensions persist, it may actually be a mild positive for STE with the private sector in some countries now more hesitant to consider Chinese technology solutions providers,”
As at 4.27pm, shares in ST Engineering are trading 6 cents higher, or up 1.53%, at $3.98. This translates into a price-to-earnings (P/E) ratio of 20.3 times and a dividend yield of 4.07% for FY19E, according to Maybank valuations.
