(June 17): For months, stock markets have been in choppy waters, no thanks to the multi-pronged trade wars started by the US. The Singapore market, facing prospects of a sharp economic slowdown, has suffered as well.
Amid the volatility, investors have fled to the relative safety of Singapore Technologies Engineering, which traded at a 52-week high of $4.10 on June 11. Year to date, it has gained 17.2% versus the Straits Times Index’s 4.75% rise in the same period.
Of the 30 component stocks in the STI, analysts are the most positive on this stock. According to Bloomberg data, ST Engineering has the biggest proportion of “buy” calls compared with other index stocks. Just two analysts, Royston Tan of Daiwa and Lorraine Tan of Morningstar, have “hold” calls on the stock; the remaining 13 rate it a “buy” or equivalent. Their price targets range between $3.90 and $4.70. Daiwa’s and Morningstar’s price targets are $4.07 and $4.36, respectively.
Their optimism is grounded on a combination of factors: improved earnings, significant inroads into new markets, contributions from newly acquired businesses and a clear roadmap into new growth areas. “We believe ST Engineering is on the cusp of the ‘next leg up’ in its growth story while trading at reasonable valuations,” says DBS Group analyst Survo Sarkar in a May 16 report. He has a “buy” call, with a price target of $4.50. The stock closed on June 11 at $4.09, which values the company at a forward price-to-earnings ratio of 21.7 times and gives it a market value of $12.7 billion.
For its most recent 1QFY2019 ended March 31, ST Engineering grew its top line by 5% y-o-y to $1.7 billion. Earnings in the same period were up 11% to $131.1 million, owing to higher margins. “We had a good start to the year, and we also had a strong quarter for contract wins, which helped us to strengthen our order book to a high of $14.1 billion,” says president and CEO Vincent Chong at the earnings call on May 15.
Aerospace and electronics
The revenue contributions have come mainly from the aerospace and electronics divisions, at 36% and 32% respectively, with land systems (22%) a distant third and marine (9%) last among the major divisions.
Land systems booked the highest increase in revenue (34% y-o-y) to $377 million on the back of higher revenues from all its business groups. Aerospace was second, with a 4% rise in revenue y-o-y to $622 million, attributed to higher revenue contribution from its component, engine repair and overhaul, and engineering and material services business groups, which offset lower revenues from the aircraft maintenance and modification business division.
Electronics, however, suffered a 7% y-o-y drop in revenue to $563 million. The decline was attributed to a strong quarter in 1QFY2018, which saw a 22% y-o-y increase in revenue to $605 million, higher than the typical revenue for the unit for the quarter. Marine also booked a 1% fall y-o-y in revenue to $149 million, dragged down by the shipbuilding unit, which was offset by better performance from the ship repair and engineering units.
As for earnings contribution, all divisions except land systems registered an increase in earnings. Aerospace reported the highest earnings among the divisions, with a 6% y-o-y increase to $62.7 million, driven by higher revenue, the absence of impact from portfolio rationalisation and lower tax expense, but partly offset by an unfavourable sales mix.
Electronics was second with an 8% y-o-y increase in earnings to $43.4 million; marine grew its earnings by 38% y-o-y to $12 million; and the land systems division saw a 3% y-o-y drop in earnings to $15.2 million.
While the company started as a bullet maker for the Singapore Armed Forces more than five decades ago, it now generates 70% of its revenue from commercial business and the remaining from military sales.
Contract wins
In the lead-up to the 1Q results, ST Engineering, according to its usual practice, announced a series of contract wins totalling $2.1 billion. The bulk was from its aerospace division, with some $1.3 billion of deals secured during the quarter, including a 10-year service agreement from a long-time customer in North America for heavy maintenance checks for its entire fleet of A300 and Boeing 757 aircraft. In addition, it won contracts from new customers in Africa and Europe to provide component repair services for Bombardier Q400 aircraft.
During the quarter, the electronics division secured $818 million worth of contracts for mobility, satellite communications, Internet of Things and cybersecurity, among others. Contracts included supplying an automatic fare collection system for Bangkok’s MRT Gold Line, maintenance and enhancement works for Bangkok’s Purple Line as well as providing a mobile communications network for Downtown Line 3’s extension, among others.
The marine division, which is on a roll after years of decline, announced a contract with the US Navy to build a US Coast Guard Polar Security Cutter. The contract is cumulatively worth $2.6 billion if the options to build a further two boats are exercised. The first delivery is expected in 2024 and the second and third delivery, should the options be exercised, in 2025 and 2027 respectively.
ST Engineering will use its US shipyard to fulfil this contract. Incidentally, the contract win underscores the lumpy project-driven nature of large engineering companies. “Just maybe a couple of months ago, we were actually rightsizing the shipyard. But now, because of this win, we have to increase our workforce,” says Ng Sing Chan, president of ST Engineering -Marine.
Investments and acquisitions
The company is placing big bets on its electronics business. It recently announced the $383 million acquisition of Newtec Group, a Belgium-based satellite communications company. The acquisition will allow ST Engineering to make deeper inroads in the European satcom business and provide the capabilities for the company’s ambitions to enter a bigger market — smart cities. “This acquisition is a meaningful development in our execution of the group’s Smart City growth [plan],” says Chong. He expects the acquisition to be earnings-accretive from 2H2020.
ST Engineering is ready to invest for organic growth too. It recently announced a JV company with SP Group called SP Telecom. The JV company has announced the intention to spend “hundreds of millions” of dollars over the next few years to build a fibre optic network in Singapore. This new network will provide an alternative connection for enterprise customers to ensure connectivity, as the lines are laid by SP Group alongside its network of power lines — which lie deeper underground and are less prone to cuts by third-party contractors.
The JV is betting that demand for data connectivity can only grow because of Singapore’s Smart Nation drive. Many big companies, which SP Telecom is targeting instead of residential users, are increasingly heavy users of cloud computing. “There is a huge demand for more bandwidth, especially at the fibre level,” says Ravinder Singh, president of ST Engineering Electronics.
In order for it to be a fully digital network, the new fibre network will be built from scratch. Customers would be able to control their connectivity easily via digital platforms because the network will not be burdened by legacy hardware assets.
“We are using software solutions, not just traditional hardware solutions, to come up with state-of-the-art solutions that are efficient and cost-effective. We will be quite selective in where we do the last-mile connectivity; we only go where it makes sense,” says CEO Chong.
US market
Under US President Donald Trump, the US has become an almost predictable market to do business with and in — which is not necessarily always bad for ST Engineering.
For example, it garnered headlines recently when Trump tweeted about Workhorse, a US automaker that ST Engineering’s US subsidiary VT Hackney partnered with for a contract to replace US Postal Service vehicles. Workhorse has confirmed that it is one of the finalists in the running.
ST Engineering says it has completed the prototype phase and delivered it for evaluation, but it cannot comment on the status of the federal contract that is worth more than US$5 billion ($6.8 billion), as the request for proposal has been issued.
Also, US regulators’ decision to ground the Boeing 737 Max aircraft may create a bit of tailwind, albeit indirectly, for ST Engineering. Its aerospace division is a major player in the maintenance, repair and overhaul market. While the company currently does not provide MRO for the 737 airframe, Lim Serh Ghee, president of ST Engineering Aerospace, notes that the impact could be net positive for its after-market services, although it is too early to say for sure. Much depends on how long the order to ground the 737 Max aircraft remains in force.
“If it stretches beyond the third quarter of this year, the airlines will start investing in the older generation aircraft to backfill the capacity loss due to the 737 Max. And if that happens, then the net positive will increase a little bit,” says Lim.
However, the bigger positive development remains the trade war, which could benefit some countries and companies. Moreover, the way Chong sees it, there is some impact from it, but it is not material, as the company’s contracts stretch over years and do not vary quarter to quarter. The different business units can help spread out the volatility too. “There are always adjustment factors that we work on with our customers. And for short lead time, we could pass the job to the market,” says Chong.
“We just have to keep watching and make sure that we optimise our supply chain, and then we strengthen our core capabilities and operations to be resilient — as resilient as we can be against the macroeconomic movements,” he adds.
