ST Engineering - Bullish long term outlook

$SINGAPORE TECH ENGINEERING LTD(S63.SI)$ announced that its shipbuilding arm, ST Marine, has been awarded a contract by the Ministry of Defence (MINDEF) for the detailed design and construction of six Multi-Role Combat Vessels (MRCVs) for the Republic of Singapore Navy (RSN). MRCVs are a type of naval warship that is designed to be versatile and flexible, capable of performing multiple roles in combat operations and combine the capabilities of several types of traditional warships, such as frigates, destroyers, and amphibious assault ships, into a single platform. The new MRCVs, upon delivery from 2028 onwards, will replace the existing Victory-class Missile Corvettes (MCVs) in the RSN, which have been in service since 1989.

According to MINDEF, the MRCVs will employ key technologies such as configurable modular payloads and unmanned systems, allowing the vessel to function as a "mothership" for unmanned drones and vessels to conduct a range of missions from peace to war. Singapore's Defence Science and Technology Agency (DSTA) and Sweden's Saab have signed a Memorandum of Understanding (MOU) to co-develop and design the MRCVs, harnessing technologies such as artificial intelligence (AI) and data analytics to realise the MRCV's concept as a highly digital ship. Meanwhile, ST Engineering will be responsible for the procurement and integration of the platform equipment and MINDEF furnished equipment. Its scope of work will also include the undertaking of design and the provision of Integrated Logistics Support Engineering to support and maintain operational readiness during the lifespan of the MRCVs.

ST Engineering has a long history of delivering new age warships both for the Singapore Navy and other navies in the region from its Singapore shipyards and execution should not be an issue. Prominent contracts for RSN in the past have included building six Formidable-class frigates that were delivered in 2007-09, and the eight Independence-class littoral mission vessels (LMVs) that were delivered over 2017-20, as well as submarines. STE has also recently secured a contract in 2021 to design and build four patrol vessels for the Royal Navy of Oman worth S$880m, but this MRCV contract should be bigger in terms of contract size.

While no information on contract value was disclosed, there are some rough estimates. Based on the contract values of similar warships deployed by other navies worldwide, costs of building MRCVs should be in the range of US$500m to a few billions, depending on the design specifics, capabilities, weapon systems etc. This is benchmarked to previous contracts for RSN warships that STE has delivered and even after excluding design costs and equipment costs, each vessel contract to STE could roughly be in the range of US$400-500m. This would amount to a total contract size of around US$2.5-3.0bn or S$3.3-4.0bn, which is quite significant compared to STE's current orderbook of S$23bn as of end-2023. Combined with other new order wins YTD in 2023 (including the S$430m contract for Kaohsiung MRT red line south extension), this could potentially take STE's orderbook to new record levels in excess of S$26bn at the end of 1Q23. High orderbook levels are typically a key catalyst for the share price.

In terms of actual earnings contribution, any significant contribution in FY23/24 is not expected but there should be more material contributions afterwards. Given the delivery timeline of 2028 and beyond, there will be early contributions from FY25 onwards assuming construction time of around 3-4 years for the warships, based on a % of completion revenue recognition schedule. Based on the total contract size estimate, the contract could add between S$180m-S$240m in net earnings to STE over a period of 6 years or so, or S$30-40m per year, implying accretion of 5.5%-7.5% compared to FY22 earnings. This is based on conservative net margin assumptions of 5-6%, compared to 7.5% average PBT margin for STE's shipbuilding business (FY04-13, before negative impact of US operations). If STE is able to execute better and achieve net margins of 10% on the contract, the accretion will be even more material at 10-12% of current Group earnings, which would be a very healthy outcome.

Thus, given the strong orderbook impetus and improved earnings visibility, STE seems to be bullish given a long term outlook. Analysts have pegged TPs of around S$4.00-4.20. This would imply around 9%-15% in potential return based on last traded price of S$3.64. On top of this, the dividend yield of STE is in excess of 4% which can easily beat the average inflation rate and is higher than CPF SA account interest rate. In my personal view, this blue chip stock with businesses in the defence industry is very good for long term investing. I am quite vested in this stock so my views could be biased. DYODD before making any trading decisions.