Flightpath to recovery
Leading engineering conglomerate; initiate with BUY
We initiate coverage with a BUY rating and DCF-based target price of
SGD4.75, offering 17% upside potential at 7.5% WACC and 2% TGR. With
borders re-opening, the aerospace landscape is improving. STE’s recent
acquisition of TransCore holds growth promise in smart city solutions and
rising defence spending could increase international sales at a robust
pace. Significant contract wins with a record-breaking FY21 order book of
SGD19.3b (+25% YoY) have provided good revenue visibility and promises
sustainable dividend yields of 2.5%. The strategy to better integrate STE’s
various divisions could surprise with revenue and cost synergies.
A confluence of drivers for FY22E-FY24E
Aerospace MRO (Maintenance, Repair & Overhaul) is witnessing green
shoots of recovery as international borders reopen. Rising demand (4.7%
YoY) for freighter aircraft should see an uptick in passenger-to-freight
(PTF) conversion contracts supported by 7% pa growth in the global aircraft
fleet. We see demand for urban and satellite communications solutions,
delivering 9.9% revenue CAGR from FY21-FY24E, with new drivers from
smart-city and ICT solutions. Recent inorganic growth has established a
strong global footprint, casting a wider net. Prospects for the defence
segment remain captivating with an addressable market of USD5b.
Greater integration to leverage on core strengths
STE’s core value proposition is offering tailored customer solutions using
a deep pool of engineering and technological expertise in multiple sectors.
The recent restructuring, which focuses on pushing greater integration
across what have historically been silo-like divisions, could be a material
positive. We project pretax profit margin to increase from 9% in FY21 to
10.2% by FY24, mainly on efficiencies in smart cities initiatives coupled
with strong order book growth (+15% YoY) to provide greater visibility for
the revenue pipeline. We also see a potential surprise to the upside from
revenue (cross-selling) and cost (central procurement, systems
standardisation) synergies in the coming 2-3 years.
Catalysts and key risks
Potential catalysts for STE include a faster-than-expected pace of global
reopening and travel relaxation. We are prudently below consensus on
FY22E-FY24E net profit due to our concerns about: a) relatively slower
opening of Asian skies; and b) global chip shortage disrupting smart device
output, dampening sales for smart-city solutions.