Back-end Loaded Year

In line with expectations, ST Engineering reported 1Q14 results with SGD137.2m PATMI (+2.4% y-o-y) on the back of SGD1.55bn revenue (+0.5% y-o-y). 1Q results was hit by recognition timing issues in Electronics and Land System business. We expect these segments to pick up as this will be a back-end loaded year. Maintain BUY with TP unchanged at SGD4.66 based on DCF (WACC: 8.4%; growth: 0%).

1Q14 results helped by wage credit scheme. Growth of PBT for the quarter would have been flat instead of a 6% y-o-y increase, if it had not been for one-off other income which jumped 85% y-o-y to SGD17.4m. These was likely due to maiden contributions from the yearly government wage credit scheme which will end in 2016.

Marine shine and Aerospace grow. Marine growth was the most outstanding of all divisions growing 27% y-o-y to SGD323m, largely due to the recognition of the Oman Navy contracts. Aerospace was the second growth sector, growing 5% y-o-y to SGD501m while the other two sectors shrunk. Going forward, we expect Marine PBT growth to normalize to single digits and Aerospace PBT growth rate to hover at the same levels.

Electronics and Land System were weak. Electronics revenue fell the most by 13% y-o-y to SGD369m while Land Systems fell 6% y-o-y to SGD325m. We believe that there is no cause for panic as it is a project revenue recognition timing issue for Electronics and Land System’s defense business. We expect more project to be completed in subsequent quarters and revenue growth should return. Land System’s commercial business continued to face weaknesses in 1Q14 due to lukewarm economic conditions in China but should see more optimism moving forward.

Record order book to provide downside cushion. Most importantly, order book continue to make new record high, hitting SGD13.4bn (+3% y-o-y). We estimate that the current order book which generally drive 60% to 70% of the annual revenue is sufficient to cover for the next three years, providing downside cushion.

Strong finish to the year but dividend cut a surprise

• 4Q13 results in line, earnings up 10% y-o-y
  
• Strong order wins reported in 4Q13; orderbook at record levels of S$13.2bn underpins earnings visibility
  
• Cuts dividend payout ratio to 80%; nevertheless net cash levels remain elevated at S$692m and can be invested for growth in US operations
  
• Maintain BUY with lower TP of S$4.30
  

Highlights

After an uninspiring performance in 3Q, STE reversed the trend with a solid set of numbers for 4Q13, with net profit up 10% y-o-y to S$167.5m on the back of 12% rise in revenue to S$1.9bn. Except the Land Systems sector, all other divisions reported y-o-y

growth in revenues, led by the Marine segment, where revenues were up 48% y-o-y on the back of strong project deliveries. PBT margins were also maintained across sectors, with Group PBT margin of 11.1% flattish compared to 4Q12 and 3Q13. However, for the full year-FY13, earnings growth was only 1% due to losses from “Others” segment – largely unprofitable non-core projects undertaken by ST Synthesis – and the impairment charge on its Ropax vessel, which has since been chartered out to a Canadian cruise ferry line for 3+7 years term. Without these items, we believe FY13 net profit of S$581m could have been up almost 6% y-o-y.

Our View

Earnings outlook remains encouraging. Order wins were buoyed in 4Q13, with all segments reporting new contract wins in the quarter that were higher than the usual run rate. As a result, STEclosed FY13 with a record orderbook of S$13.2bn despite strong

revenue recognition in 4Q13.

Recommendation

Dividend cut will affect sentiment in near term, but doesn’t change fundamentals. STE cut its dividend payout ratio from 90% to 80% in FY13 (final dividend of 12Scts + 3Scts interim already paid out) as most of the cash flow growth is trapped in the US operations due to the 30% withholding tax hurdle. However, this does not take away STE’s cash generation ability as it ended the year with a higher net cash balance of S$692m. The US operations will continue to invest the cash in expanding its capabilities in aircraft cabin reconfiguration and VIP completions, and is also exploring the possibility of setting up a MRO facility near Pensacola Airport. While we cut our TP to S$4.30 to account for the lower dividend payout and dividend growth expectations over the next 2 years, and expect some negative reaction to stock price in the near term given that STE is traditionally considered a steady dividend stock, we believe this should provide opportunities to accumulate a quality company with leverage to the global recovery story along with 4%+ yield.

Strong finish to the year but dividend cut a surprise

• 4Q13 results in line, earnings up 10% y-o-y
  
• Strong order wins reported in 4Q13; orderbook at record levels of S$13.2bn underpins earnings visibility
  
• Cuts dividend payout ratio to 80%; nevertheless net cash levels remain elevated at S$692m and can be invested for growth in US operations
  
• Maintain BUY with lower TP of S$4.30
  

Highlights

After an uninspiring performance in 3Q, STE reversed the trend with a solid set of numbers for 4Q13, with net profit up 10% y-o-y to S$167.5m on the back of 12% rise in revenue to S$1.9bn. Except the Land Systems sector, all other divisions reported y-o-y

growth in revenues, led by the Marine segment, where revenues were up 48% y-o-y on the back of strong project deliveries. PBT margins were also maintained across sectors, with Group PBT margin of 11.1% flattish compared to 4Q12 and 3Q13. However, for the full year-FY13, earnings growth was only 1% due to losses from “Others” segment – largely unprofitable non-core projects undertaken by ST Synthesis – and the impairment charge on its Ropax vessel, which has since been chartered out to a Canadian cruise ferry line for 3+7 years term. Without these items, we believe FY13 net profit of S$581m could have been up almost 6% y-o-y.

Our View

Earnings outlook remains encouraging. Order wins were buoyed in 4Q13, with all segments reporting new contract wins in the quarter that were higher than the usual run rate. As a result, STEclosed FY13 with a record orderbook of S$13.2bn despite strong

revenue recognition in 4Q13.

Recommendation

Dividend cut will affect sentiment in near term, but doesn’t change fundamentals. STE cut its dividend payout ratio from 90% to 80% in FY13 (final dividend of 12Scts + 3Scts interim already paid out) as most of the cash flow growth is trapped in the US operations due to the 30% withholding tax hurdle. However, this does not take away STE’s cash generation ability as it ended the year with a higher net cash balance of S$692m. The US operations will continue to invest the cash in expanding its capabilities in aircraft cabin reconfiguration and VIP completions, and is also exploring the possibility of setting up a MRO facility near Pensacola Airport. While we cut our TP to S$4.30 to account for the lower dividend payout and dividend growth expectations over the next 2 years, and expect some negative reaction to stock price in the near term given that STE is traditionally considered a steady dividend stock, we believe this should provide opportunities to accumulate a quality company with leverage to the global recovery story along with 4%+ yield.

Orderbook Hits New High

STE’s 4Q13 PATMI of SGD167.5m (+10.0% y-o-y), earned on the back of SGD1.94bn in revenue (+12.1% y-o-y), was slightly below expectation. Its orderbook reached a new high of SGD13.2bn, of which SGD4.3bn is expected to be delivered in FY14. Elsewhere, the outlook for all of its divisions, except land systems, is positive. Maintain BUY, with our DCF-based TP raised to SGD4.66 (WACC: 8.4%; growth: 0%).

Aerospace unit to perform. Singapore Technologies Engineering (STE)’s aerospace unit reported a PBT of SGD88.2m (+14.4% y-o-y) and revenue of SGD590.6m (+4.3% y-o-y) in 4Q14. The contracts announced in 4Q13 exceeded SGD780m, bringing the announced contract value to SGD2.3bn in total. Going forward, the group’s revenue is likely to be higher, with comparable profits, as its new operations in Guangzhou and Texas take time to ramp up while incurring more costs during their start-up periods. Its investment pact with Pensacola city in the US to develop a new airframe facility, as well as the initial portfolio of its aircraft leasing business, are expected to be finalised in FY14.

FY14 a better year for electronics, marine units. During the quarter, the electronics division reported a PBT of SGD46.7m (+27.8% y-o-y) and revenue of SGD529.8m (+18.7% y-o-y), while the marine unit booked a PBT of SGD47.1m (+28.4% y-o-y) and revenue of SGD377.9m (+48.6% yo-y). Going forward, both sectors are likely to report higher PBT and revenue in FY14, backed by a strong orderbook.

But downbeat on land systems. The land systems unit’s strong turnaround in 4Q13 – with 11.3% and 126.4% q-o-q jumps in revenue and PBT respectively – was due to a one-off gain from a property disposal. Still, its near-term outlook remains sluggish as macroeconomic conditions remain volatile and spending on capital equipment delayed.

Dividend payout ratio drops to 80%. While STE’s historical dividend payout ratio was c.90% of profit, FY13’s final dividend of SGD0.12 was only 80% due to a 30% withholding tax at its businesses overseas that restricts the flow of cash back to shareholders. Hence, the payout ratio will likely drop to 75% as the group aims to retain its overseas earnings to grow its businesses.

FY13 results in line

• FY13 EPS flat YoY
  
• 80% dividend payout vs. 90%
  
• Maintain HOLD
  

Land Systems’ gain on property disposal

STE reported a set of FY13 results that were generally in line with ours and the street’s expectations. FY13 EPS of 18.73 S cents (flat versus FY12’s 18.76 S cents) formed 99% and 104% of the street’s and our forecasts. 4Q13 revenue grew 12% YoY and 25% QoQ to S$1.94b. Recall that 3Q13 was a disappointing quarter partially due to lower gross profit from Aerospace and Land Systems and an impairment of S$23.7m for ROPAX. On a QoQ basis, all four sectors registered higher revenue and PBT in 4Q13: Aerospace (+15%/+12%), Electronics (+49%/+9%), Land Systems

(+12%/+126%) and Marine (+27%/39%). Revenue growth was driven primarily by Electronics, which saw milestones completions of an air traffic control system, LTA’s communications systems projects, higher sales of satellite communication products and electro-optics equipment. Land System’s PBT jump to S$39.6m was chiefly due to gain on disposal of a property, higher revenue and lower operating expenses.

2013 round-up

FY13 revenue was S$6.63b, up 4%. PBT and net profit were S$730m (+2%) and S$581m (+1%). Commercial sales accounted for 62% of revenue. As of end-2013, order book was S$13.2b, up 9% YoY. Final ordinary and special dividends of 4.0 S cents and 8.0 S cents bring FY dividends to 15.0 S cents, versus 16.8 S cents for FY12. Payout ratio is 80%, versus ~90% for FY09-FY12.

Guidance for 2014

Management expects revenue and PBT in FY14 to be higher. For Aerospace, revenue is expected to be higher, but PBT is expected to be comparable. For Electronics and Marine, FY14 revenue and PBT are expected to be higher. For Land Systems, FY2014 revenue is expected to be comparable, whilst PBT is expected to be lower. But STE notes that dividend payout ratio may track lower to 75% over the next 3-5 years as its overseas operations grow further.

Maintain HOLD

We lower our FY14F EPS estimate slightly to 20.2 S cents from 20.6 S cents and trim our FV to S$3.84 (19x P/E peg) from S$3.91. Maintain HOLD.