To The Moon

$SINGAPORE TECH ENGINEERING LTD(S63.SI)$ 

ST Engineering (STE)'s share price has been underperforming over the past few months. I think the main reason is due to an increase in STE's total debt to S$6.2bn in 1H22, leading to higher finance costs. Also, the anticipated earnings accretion from the Transcore acquisition is yet to be realized and is expected to come only in 2H23F. Furthermore, STE's FY22 PATMI was slightly lower than expected due to the impact of higher input costs in the inflationary environment on its margin.

Despite these challenges, STE’s growth prospects are expected to improve in 2023, driven by a record order-book of S$23bn, a decrease in losses from passenger-to-freighter (PTF) conversion, and the recovery of global air travel, which should lead to better operating leverage in commercial aerospace (CA). Additionally, the divestment of the loss-making Marine shipyard, Transcore, in the US, which incurred losses of approximately US$50m, could result in a significant EPS uplift in 2023.

FY22 Earnings review

STE's revenue reached S$9bn, with Defence and Public Security (DPS) accounting for 47%, followed by commercial aerospace (CA) (33%) and urban solutions and satcom (USS) (20%). Despite strong topline performance, PATMI was slightly below the forecast, down 6% YoY to S$535m due to higher operating costs amid the inflationary environment.

CA registered 21% YoY revenue growth to S$3bn, with EBIT growing 65% YoY to S$301m. Management is optimistic about the prospects of CA, and STE secured more order wins for PTF conversion. USS revenue grew 49% to S$1.8bn, and the consolidation of Transcore added to its top-line growth. However, EBIT performance was lacklustre due to the S$30m transaction and integration costs relating to the Transcore merger. Despite chip shortages affecting profitability, STE expects the Transcore acquisition to turn earnings accretive from its second year onwards post-acquisition in 2022. With the recent divestment of its loss-making US Marine business, the group's profit would no longer be negated by losses in the US Marine segment.

2023 – Recovery year?

All three STE business segments are on track for margin recovery in FY23F. Urban Solutions & Satcom is expected to experience a full-year consolidation from Transcore with stronger margins than STE, and a reduction in integration/transaction costs.

Commercial Aerospace should see an increase in contribution from associates as well as a reduction in losses as it progresses along the passenger-to-freighter (PTF) conversion learning curve, with the aim of becoming EBIT positive.

Lastly, Defence and Public Security, which experienced lower margins due to higher energy costs in 2H22, is expected to see some relief in addition to the absence of annual losses of about c.US$60m (S$80m) with its exit from the US Marine business.

Rising military defence budget is still a key driver!

DPS's order win of S$5.2bn in 2022 may have been underappreciated. While STE may not have directly benefited from the Ukraine/Russia conflict, the sustainable increase in Singapore's defense budget has been a positive catalyst for the company. The Singapore government has increased its defense budget to S$17.98bn, which is a 6% year-on-year increase for 2023F. This increase is due to the resumption of deferred projects caused by Covid-19 and higher inflationary pressure. Approximately S$17.04bn will be allocated to the Singapore Armed Forces, which is one of STE's customers. Also, STE's acquisition of the 141k sq m Gul yard from Keppel, which will replace its expiring Tuas yards lease in 2024, is timely for the company to win more defense-related projects.

Conclusion

STE's strong order book, advanced engineering capabilities, and the increasing defence spending make it a compelling investment choice for SG investors seeking exposure to the defence sector. As the STE continues to expand its presence in the defence and engineering sectors, it is well-positioned to benefit from the expanding military budget in Asia and other regions.

The current PE multiple of STE is 18x FY23EPS, which is kinda inexpensive compared to its 15-year forward P/E of 20x

@Daily_Discussion @TigerStars