1H22 in line, aerospace recovery encouraging
1H22 net profit of S$279.9m (+2.0% h-o-h, -3.8% y-o-y) was broadly in line with expectations, accounting for 49% of the consensus’s full-year estimate. If we were to exclude one-off costs, mainly related to TransCore transaction and integration costs, net profit would have been up 4.0% y-o-y to S$307.0m. Group revenue in 1H22 was up by 17.0% y-o-y to S$4,269.9m, driven by broad-based growth across all business divisions and start of contribution from TransCore (acquired in March-22).
Absence of government grants support not felt. Business recovery and cost savings of S$104m, coupled with a one-off pension restructuring gain of S$72m in 1HFY22 more than offset the absence of the S$125m in government grants related to COVID-19-related support measures received by STE in 1H21. Excluding transaction and integration costs for TransCore, government support and one-off pension restructuring gain, group core EBIT would have been S$333m in 1HFY22, up 45% y-o-y, which is an encouraging sign of recovery, especially driven by the Commercial Aerospace division. The pension restructuring gain also occurred in an overseas subsidiary in the Commercial Aerospace division, but even without this impact, Commercial Aerospace margins were tracking above our estimates (core EBIT margin of around 8% compared to our expectations of around 6%). This helped offset the lack of growth momentum in Urban Solutions & Satcoms division performance in 1H22.
The group appears to be coping well with rising cost pressures. Core EBIT margin climbed sequentially to 7.7% in 1HFY22 (from 5.9% in 2HFY21 and 6.2% in 1HFY21).
Commercial aerospace segment saw significant top line growth to S$730m (+25% y-o-y) in 2QFY22, representing 93.4% of the pre-pandemic levels. Momentum in the division continues to be strong, given robust demand in STE’s OEM operations (nacelles and P2F); MRO revenue has been recovering at a relatively slower pace, especially on the engines and components MRO side, but should continue to rebound as global flight traffic continues to normalise to pre-COVID19 levels.
TransCore comes into the picture in 2Q22 but earnings accretion won’t be felt until FY23. Urban Solutions & Satcoms division revenue grew by 54.8% q-o-q and 74.2% y-o-y to S$460m in 2QFY22, driven by the full quarter contribution of TransCore during the period, though tempered by lower revenue from STE’s satcom business due to semiconductor chip shortages.
Defence & Public Security (DPS) segment revenue was flat q-o-q at S$1,046m in 2QFY22; defence aerospace, digital systems and cyber and land systems sub-segments registered healthy 7-12% growth, but the marine segment saw a marginal decline due to supply chain bottlenecks.
Order backlog of S$22.2bn as of June-22 represents yet another new high for the group, with an implied book-to-bill ratio of 2.6x. Management guided for S$4.6bn worth of contracts to be delivered in 2H22, which suggests there could be a slight upside to consensus’ revenue and earnings estimates for FY22F. STE clinched S$3.1bn worth of new contracts in 2Q22, bringing YTD contract wins to S$5.5bn and tracking well to beat FY21 full year order wins of S$11.7m, given the usually stronger second half.
Quarterly dividend of 4.0Scts per share was announced, as per changes to their dividend policy to quarterly distributions from semi-annual distributions. Full-year DPS of 16.0Scts per share in FY22 represents a dividend yield of around 4% based on current share price levels. Despite higher capex and related borrowings to fund the TransCore acqusiition, STE continues to maintain high credit ratings, implying relatively low funding costs (spreads) in a high interest rate environment. STE can also choose to access equity capital markets if debt funding window is unfavourable for long.
More than just a safe haven stock. ST Engineering has historically often been considered a safe haven stock, outperforming volatile markets like we are in today, owing to its defensive nature. And that story still holds, with a secure dividend yield of around 4% at current prices. But the added kicker now is the growth. We see two big drivers to 2023 and beyond – inorganic growth (TransCore) and the recovery we are seeing in commercial aerospace – and growth momentum won’t stall beyond that. With continued investments in R&D and strategic acquisitions, STE remains well on top of crucial global needs of sustainability, digitalisation, urbanisation, and security, which will drive growth via 1) Passenger to Freighter (P2F) conversions pipeline, 2) smart city projects, 3) expansion in cloud, AI analytics, and cybersecurity and 4) international defence contract wins. Maintain BUY with an unchanged TP of S$4.70.