Elevator Pitch
Singapore-listed Singapore Technologies Engineering (OTCPK:SGGKF) (OTCPK:SGGKY) [STE:SP], is a conglomerate with diversified business operations in Aerospace, Electronics, Land Systems, and Marine, which contributed 39%, 32%, 19%, and 9% of its FY2018 revenue respectively.
Singapore Technologies Engineering trades at 20.2 times consensus forward FY2020 P/E, which is on par with its historical five-year average forward P/E of approximately 20.5 times. The stock offers a consensus forward FY2020 dividend yield of approximately 3.8%. The market consensus is expecting a +13% YoY earnings growth for Singapore Technologies Engineering in FY2020, versus a low-to-mid single-digit historical earnings growth for the company in FY2017 and FY2018. Singapore Technologies Engineering's share price has also out-performed the Singapore benchmark Straits Times Index by a significant margin year-to-date.
Singapore Technologies Engineering's future long-term growth prospects are promising, with the company's five-year earnings growth target of two to three times the global GDP growth driven by M&A and Smart Cities opportunities. In the near term, there could be a potential for earnings disappointment, given the company's share price out-performance year-to-date and the high consensus earnings growth expectations.
This is an update of my initiation article on Singapore Technologies Engineering published on July 15, 2019. Singapore Technologies Engineering's share price has declined slightly by -2% from S$4.29 as of July 12, 2019 to S$4.19 as of November 20, 2019. I retain my "Neutral" rating on the stock, as I think that the stock's current valuation is unappealing at 20 times forward P/E despite attractive long-term growth prospects.
End-Of-Program Reviews Led To Higher-Than-Expected Revenue And Associated Impairments & Provisions
Singapore Technologies Engineering recently announced its 3Q2019 results on November 11, 2019. Excluding an one-off S$11 million provision relating to the results of arbitration proceedings between its wholly-owned U.S. marine subsidiary, VT Halter Marine, Inc. and Hornbeck Offshore Services (HOS), the company's core net profit in 3Q2019 was S$150 million, up +9% QoQ and +12% YoY.
Prior to the release of 3Q2019 results, Singapore Technologies Engineering was already expected to deliver strong YoY revenue growth in the most recent quarter, due to the completion of the acquisition of MRA Systems, LLC or MRAS, an Original Equipment Manufacturer or OEM of engine nacelle systems on April 18, 2019. But the company's +27% YoY revenue growth to S$2,069 million in 3Q2019 was still much higher than expected, due to various end-of-program reviews. The end-of-program reviews also led to associated impairments and provisions.
Singapore Technologies Engineering is engaged in multiple multi-year contracts or programs at any one time. At the start of a program, the company recognizes certain revenues and costs gradually on a percentage of completion basis, as the program proceeds. At the end of a program, it does a reconciliation of both revenues and costs. In 3Q2019, impairments and provisions associated with various end-of-program reviews were exceptionally large.
Singapore Technologies Engineering recognized S$51.8 million in impairment losses on trade receivables & contract assets (relating to Aerospace and Electronics segments) and S$40.5 million of allowance for inventory obsolescence (relating to Aerospace and Land Systems segments) in 3Q2019. Impairment losses on trade receivables are largely attributable to the company's end-of-the-program reviews. The bulk of the S$40.5 million allowance for inventory obsolescence relates to rotables or aircraft spare parts relating to certain legacy programs which the company has been impairing since 2014.
For companies where multi-year contracts account for a significant part of their business such as Singapore Technologies Engineering, the percentage-of-completion method of earnings recognition is dependent on estimates of total costs and revenues for any single contract or program. While revenue is fairly certain in most cases (with the exception of certain additional revenue to be recognized upon achievement of specific milestones or performance of specific obligations), cost overruns are not uncommon and cost estimates can change during the multi-year period of the contract or program. As such, the possibility of such future adjustments to revenues and costs relating to end-of-program reviews cannot be ruled out.
The good news is that going forward, the impairment expense for rotables relating to legacy programs is likely to be much lower, because Singapore Technologies Engineering highlighted at its 3Q2019 earnings call on November 11, 2019 that it "will be closing the chapter on this so-called legacy asset."
New Contract Wins And Strong Order Book Imply High Future Expectations
Singapore Technologies Engineering secured new contract wins of approximately S$1.8 billion in 3Q2019, of which S$1 billion was attributed to its Aerospace business, and the other S$800 million relating to its Electronics business. The company's Aerospace and Electronics business segments contributed approximately 47% and 34% of its 9M2019 net profit after tax respectively. Year-to-date, the company's new contract wins of S$5.4 billion in 9M2019 has already surpassed FY2018's new contract wins of approximately S$5.2 billion.
Singapore Technologies Engineering has a record high order book of $15.9 billion as of end-September 2019, of which it expects to recognize S$2.2 billion in 4Q2019. The company's current order book is equivalent to more than two years of revenue, based on its FY2018 revenue of S$6,698 million, implying significant revenue visibility.
Looking ahead, Singapore Technologies Engineering emphasized at the company's 3Q2019 results briefing on November 11, 2019 that "all sectors have a pretty robust order book across, and we will continue to put our efforts in winning new projects that we have not let up."
On the flip side, expectations for Singapore Technologies Engineering are high, with the company's significant new contract wins and record order book. The company's share price increased +18.9% year-to-date (excluding dividends), while the Singapore benchmark Straits Times Index is up only +5.7% over the same period. Also, the market consensus expects Singapore Technologies Engineering to deliver a +13% earnings growth in FY2020, while the company's historical earnings growth rates in FY2017 and FY2018 were in the low-to-mid single digits.
Aerospace Segment Could Pose Downside Earnings Risks Due To A Slowdown In Airbus Production
As highlighted in the preceding section, the Aerospace segment is arguably Singapore Technologies Engineering's most important business for the company, as it contributed 47% of its 9M2019 net profit and 55% of its new contract wins in 3Q2019.
Within the aerospace business segment, the newly acquired MRA Systems, LLC or MRAS, could pose downside earnings risk. As an OEM of engine nacelle systems, MRAS is also the single source provider for the current A320neo (using LEAP-1A engines) nacelle systems supply contract in partnership with Safran. The long-term growth outlook for MRAS is promising, considering that Airbus (OTCPK:EADSF) (OTCPK:EADSY) has predicted 37,390 new aircraft deliveries in the 20-year period between 2018 and 2037, which implies a more than doubling of the current global aircraft fleet.
However, there is a possibility of earnings disappointment from MRAS in the near-term. In end-October 2019, Airbus reduced its full-year FY2019 delivery target from the earlier guidance of 880-890 planes to 860 planes. This was attributable to production delays at Airbus' plant in Hamburg, Germany. On November 18, 2019, Reuters reported that Kuwait's Jazeera Airways is not placing aircraft orders with Airbus at the Dubai Airshow, because of delays in the delivery of Airbus aircraft. MRAS' growth momentum could be possibly affected by Airbus production delays in the short term.
Long-Term Growth Drivers Remain Intact
At the company's Investor Day in March 2018, Singapore Technologies Engineering had set a target of growing the company's revenue and net profit by two to three times the global GDP growth in the next five years. In my opinion, there are two key growth drivers to help the company meet this target, namely Smart Cities and mergers & acquisitions.
I have discussed about Singapore Technologies Engineering's growth opportunities in Smart Cities in detail in my initiation article on the stock, which I made reference to in the "Elevator Pitch" section of this article. The company aims to double its current Smart Cities-related revenue to S$1 billion by 2022.
The company is on the right track judging by recent contract win momentum. Most of Singapore Technologies Engineering's Electronics segment revenue is related to Smart Cities growth opportunities. In 3Q2019, the Electronics segment secured approximately S$800 million in new contract wins, which included a significant S$300 million Smart Cities-related emergency response services contract.
With respect to M&A, Singapore Technologies Engineering's pace of acquisition has accelerated in the past two years. The company spent more than S$1 billion acquiring new companies in FY2018 and 9M2019, while it spent less than S$250 billion in total on M&A in the five years between FY2013 and FY2017. Looking ahead, Singapore Technologies Engineering still has the appetite for further M&A.
In an interview with local media, The Edge, published on November 18, 2019, Jeffrey Lam, deputy president of ST Engineering Aerospace (aerospace business of Singapore Technologies Engineering), said that "we are still hunting for more, but it has to be the right ones, the more impactful ones," implying that the aerospace business was still on the lookout for future acquisition opportunities.
Valuation
Singapore Technologies Engineering trades at 22.9 times consensus forward FY2019 P/E and 20.2 times consensus forward FY2020 P/E based on its share price of S$4.19 as of November 20, 2019. The stock's forward FY2020 P/E is on par with its historical five-year average forward P/E of approximately 20.5 times.
Singapore Technologies Engineering offers consensus forward FY2019 and FY2020 dividend yields of approximately 3.7% and 3.8% respectively. Singapore Technologies does not have an official dividend policy, but it has paid out an annual dividend per share of S$0.15 since FY2013.
Variant View
The key risk factors for Singapore Technologies Engineering are higher-than-expected impairments & provisions relating to future end-of-program reviews, lower-than-expected new contract wins, integration issues with recently acquired companies and overpaying for future acquisitions.
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