ST Engineering: Aerospace MRO leading the way
- 1H23 core earnings of around S$300m (+7% y-o-y) was better than the street despite weakness in satcom segment
- Commercial aerospace division strength leads Group core operating margin rebound to pre-pandemic levels
- Orderbook surges to new high of S$27.7bn, underpinning multi-year growth visibility
- Maintain BUY with TP of S$4.20
2QFY23 revenue came in at S$2,574m (compared to 1QFY23 revenue of S$2,289m (+12.5% q-o-q, +15.1% y-o-y), bringing total revenue to S$4,863m in 1HFY23, constituting 50% of the street’s full-year estimate, again above expectations given that 2H is anticipated to be stronger.
Commercial aerospace (CA) segment shows stronger than expected rebound. While the group saw revenue growth across all segments in 1H23, revenue, CA segment witnessed remarkable strength with revenue growth of 35% y-o-y, led by a strong recovery in its engines and component business, robust P2F demand and increased nacelle deliveries. CA segment margins also rebounded with higher activity levels, and excluding the one-off pension restructuring gain realised in 1H22, CA segment EBIT would be up 60% y-o-y.
This offset weakness in the Urban Solutions and Satcom (USS) segment. The group’s satcom business continues to be adversely impacted by supply chain disruptions, and while USS revenue was up 18% y-o-y driven by the Urban Solutions business, the division overall saw EBIT losses of S$34m, affected by satcom business weakness, severance expenses and divestment loss on an investment (SatixFy) that dragged down EBIT by S$52m. TransCore earnings accretion will also take place by 2H23. For the USS segment, management expects some relief by end-2023, as revenue in both the urban solutions and satcom division will be skewed to 2HFY23, due to the timing of project and contract delivery schedules (for both TransCore and the satcom business), leading to better margins and absence of one-off expenses. Full-year EBIT for the division is likely to revert back to the black and be comparable to FY22 EBIT levels (S$29m).
Defence & Public Security (DPS) segment benefits from absence of losses from US shipyard operations. 1H23 revenue growth for the DPS segment was flat y-o-y but would have been up 6% if we excluded the US marine operations in 1H22. The absence of US marine operations however, led to strong rebound in profitability, as expected, and overall segment EBIT grew 41% y-o-y.
Core operating margin narrowed slightly in 2H22. Core EBIT margin of 9.1% in 1H23 was a significant improvement over the 7.4% EBIT margin registered in 1H22, despite weakness in the satcom business, and has now recovered to pre-pandemic levels, despite inflationary pressures.
Segment wise trends and outlook:
Commercial aerospace:
- Airframe hangars are currently operating at capacity, while engine & component shops are also very busy, and the group is completing its fourth hangar in Guangzhou. Additionally, several new hangars are expected to commence construction in 2023, including one in Ezhou (China) and two more in Pensacola.
- CA segment EBIT margins were surprisingly strong in 1H23 at 9.6% but STE expects segment margins to sustain into 2H23.
- Pratt & Whitney’s geared turbofan (GTF) engine issues will not have a direct impact on STE as STE is focused on servicing CFM Leap-1A engines and unable to work on GTF engines. However, STE could benefit over the longer-term, given that airlines are increasingly switching away from P&W GTF engines to the LEAP-1A engine. No direct impact on nacelle production as well.
- P2F programme was gross profit positive in 1H23, and on-track to turn EBIT positive for full-year FY23. The group is maintaining its EBIT margin target for P2F programme of high single digit by FY25, and hopefully low double-digit margins thereafter.
- Significant P2F contract win from an aircraft lessor during this quarter, STE also saw long-term MRO contract renewals and new customers as well.
Urban solutions & satcom
- Momentum continues to be robust in smart city business – as demand for mobility, rail and road, and urban solutions continue to be among top priorities for customers, seeing more opportunities to bring TransCore solutions to Asia.
- Macroeconomic headwinds will continue to weigh on satcom business as STE is seeing delays in projects, with satellite operators deferring purchases.
- Meanwhile, chip shortages are expected to still have an adverse impact on the business in 2023.
- Streamlining satcom business, with 20% workforce reduction to enable cost savings.
- Will continue to see S$10m in transaction and integration costs over 2023-2024 related to TransCore.
- TransCore acquisition was not accretive to earnings in FY22, owing to high transaction & integration costs, but we expect it to start contributing to earnings from 2H23/ FY23 onwards, as project deliveries are weighted in 2H23.
Defence and public security
- Contract wins of S$5.2bn in 1H23 of was already higher than full-year FY22; STE continues to be optimistic on securing more international defence contracts.
- Losses from the US marine business was around US$55-60m in FY22, will no longer have this overhang going forward with the divestment of the US marine business.
Orderbook soars to a new peak again. STE maintained 2Q23 new order wins at close to record levels at S$4.7bn, with a particularly strong showing in its commercial aerospace (S$2.3bn) and defence and public security (S$1.9bn) segments. This brings total contract wins in 1HFY23 to S$9.5bn, lifting the group’s orderbook to a record S$27.7bn as of June-23.
Impact to financing costs remains moderate. STE’s borrowings increased by more than S$4bn in FY22 to finance the acquisition of Transcore, but STE’s cost of funding continues to be highly competitive, supported by its stellar credit rating. The group recently issued a US$500m three-year fixed rate bond at an effective yield of 3.3% (after amortisation of T-lock gains) and projects its all-in cost of debt to only inch up slightly to mid-3% in FY24 from low-3% in FY23 (and 2.4% in FY22). We reckon this is not that prohibitive and lower than our earlier assumptions. The Group projects total borrowings to reduce from S$6.2b in Jun’23 to mid-S$5b in Dec’23 from operating cash flow and aviation asset sales to JVs. Fixed to floating ratio is now 65:35 (compared to 53:47 at end-FY22) following the issue of the above bond.
Given the prolonged weakness in the satcom segment, we adjust earnings estimates for FY23/24. While the USS segment performance is projected to improve in 2H23, it will be below our initial expectations, and while the CA segment’s strength is offsetting this partly, we cut our FY23/24F earnings estimates by around 6%/4% to remain on the conservative side.
Quarterly dividend of 4.0Scts per share as expected, was announced for 2Q23, as per changes to the dividend policy to quarterly distributions from semi-annual distributions. Full-year DPS of 16.0Scts per share represents a dividend yield of around 4.2% based on current share price level.
Share price has trended sideways, time for a breakout? STE’s share price has largely trended sideways for a while now, while still doing better than the broad market (STI) YTD in 2023. With the 1H results looking better than expected, especially commercial aerospace segment strength, this could promise better share price trajectory ahead. With the full contribution of TransCore acquisition coming in from FY24, we are expecting 12% earnings CAGR over FY22-24, and better than trend organic growth even beyond that, driven by the record orderbook levels.
Maintain BUY with unchanged TP of S$4.20 as we roll over valuations to blended FY23/24F estimates.
FY Dec | 1H2022 | 2H2022 | 1H2023 | % chg yoy | % chg hoh |
Revenue | 4,270 | 4,765 | 4,863 | 13.9 | 2.1 |
Cost of Goods Sold | (3,421) | (3,915) | (3,883) | 13.5 | (0.8) |
Gross Profit | 849 | 850 | 980 | 15.5 | 15.4 |
Other Oper. (Exp)/Inc | (475) | (508) | (560) | 17.8 | 10.1 |
Operating Profit | 374 | 341 | 421 | 12.6 | 23.2 |
Other Non Opg (Exp)/Inc | 0 | 0 | 0 | - | - |
Associates & JV Inc | 11 | 22 | 24 | 115.4 | 5.4 |
Net Interest (Exp)/Inc | (33) | (104) | (93) | (177.1) | 10.9 |
Exceptional Gain/(Loss) | 0 | (13) | 0 | - | - |
Pre-tax Profit | 351 | 246 | 351 | 0.1 | 42.6 |
Tax | (69) | 15 | (66) | (3.9) | - |
Minority Interest | (2) | (6) | (5) | (97.9) | (20.1) |
Net Profit | 280 | 255 | 281 | 0.2 | 10.0 |
Net profit bef Except. | 280 | 268 | 281 | 0.2 | 4.6 |
EBITDA | 612 | 653 | 711 | 16.1 | 8.8 |
Margins (%) |
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Gross Margins | 19.9 | 17.8 | 20.2 |
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Opg Profit Margins | 8.8 | 7.2 | 8.6 |
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Net Profit Margins | 6.6 | 5.4 | 5.8 |
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