1H22: Core Profit Missed; Looking Forward To A Better 2H
STE’s 1H22 headline net profit of S$280m was helped by a number of one-off items. 1H22 core net profit of S$202m was a miss, at 38% of our full-year forecast. 2H22 core performance should improve from 1H22, driven by the continued recovery of the CA segment and potential higher project delivery by the DPS segment. Cost pressure would weigh on STE’s core profitability in the medium term. We cut 2022-24 core net profit forecasts by 7.4-9.6%. Maintain BUY with a lower target price of S$4.40.
• 1H22 headline net profit helped by one-off items. Singapore Technologies Engineering’s (STE) 1H22 reported net profit of S$280m (-5.5% yoy) was overall positively affected by a number of one-off items, with some major ones being: a) a S$72m pension restructuring gain (pre-tax), b) favourable fair value changes on corporate venture investments and divestment gains on associates and property, plant and equipment (PPE) totalling S$22.3m, c) S$13.4m gain from disposal of subsidiaries, and d) transaction costs and integration expenses of S$21m (pre-tax) related to TransCore (acquisition completed in Mar 22).
• Core performance below expectations. Excluding all one-off gains/expenses, STE’s core net profit of S$202m (by our estimate) came in below expectations, at 38%/35% of our/consensus 2022 full-year projection. 1H22 was almost free of government support (only a minor S$0.5m in 1H22 vs S$125m in 1H21). On a yoy basis, core net profit (excluding government grants) rose 38.7% on the back of significant profitability recovery in the Commercial Aerospace (CA) segment, higher contribution from Defence & Public Security (DPS) segment, offset by weaker performance in the Urban Solutions & Satcom (USS) segment. Group revenue rose 17% yoy to S$4.27b in 1H22 (1H21: S$3.65b).
• Strong CA performance… CA revenue rose 23.6% yoy to S$1.40b in 1H22 (1H21: S$1.14b), driven by increased Maintenance Repair and Overhaul (MRO) service volume and higher nacelle delivery as the CA segment continues to recover. Excluding the one-off pension restructuring gain, CA operating profit stood at S$103m in 1H22, which exceeded our expectations at 88% of our full-year projection. The outperformance was due to the faster-than-expected recovery in operating margin (1H22: 7.3%), which was in turn driven by business volume recovery coupled with a favourable operating margin.
• …offset by weakness in USS. USS revenue rose 43.5% yoy to S$0.76b in 1H22 (1H21: S$0.53b), driven by fresh contribution from TransCore but partly offset by lower revenue contribution from STE’s satcom business. Excluding one-off transaction and integration expenses related to TransCore, USS operating profit was S$11m in 1H22, significantly below our expectations at only 11% of our full-year forecast. According to management, the group’s satcom and IoT businesses were adversely impacted by the global chip shortage.
• DPS profitability weighed by cost pressure. DPS revenue rose 6.1% yoy to S$2.11b in 1H22 (1H21: S$1.99b), driven by higher contribution from Land Systems, Digital Systems & Cyber and Defence Aerospace subsegments but partly offset by slightly lower contribution from the Marine subsegment. DPS operating profit of S$214m (+2.3% yoy) was below our expectations at 38% of our full-year forecast. We believe the miss was attributable to: a) timing of project delivery (we expect higher project delivery in 2H22), and b) lower-thanexpected operating margin (9.3% in 1H22 vs our 2022 projection of 10.8%) due to cost pressures related to supply chain disruption and higher energy costs.
• Net gearing elevated post the TransCore acquisition. Net gearing (excluding lease liabilities) stood at 194% at end-1H22 by our estimate vs 27% at end-21, due to the debt financing for the acquisition of TransCore (acquisition completed in Mar 22). According to management, 55% of the borrowings are based on fixed interest rates. Rising interest cost pressure for the floating portion has been duly reflected by our financial projection (we forecast interest expenses of S$112m-142m in 2022-24, vs S$45m in 2021).
• Second interim dividend of 4 S cents. In line with the group’s guided policy, STE declared a second interim dividend of 4 S cents per share, payable on 2 Sep 22.
• Record-high orderbook of S$22.2b. STE’s orderbook rose further to S$22.2b at end-1H22 (end-1Q22: S$21.3b, end-2021: S$19.3b). STE won S$3.1b worth of contracts in 2Q22 (1Q22: S$2.4b), comprising S$1.2b contracts for CA, S$0.4b for USS and S$1.4b for DPS. We expect STE’s revenue growth to be underpinned by its strong orderbook in the medium term.
• Expecting better core performance in 2H22. We expect STE’s core profitability to improve in 2H22, driven by: a) continued recovery in the CA (STE plans increase nacelle production to 53 sets per month by end-22 vs an average of 48 sets in 1H22), and b) expected higher project delivery by the DPS segment. STE guided to deliver S$4.6b worth of projects from its orderbook in 2H22; this is S$1b higher compared with its project delivery guidance for 2H21 a year ago.
• Some margin pressure likely in the near-medium term. While we expect STE’s core profitability to improve going forward driven by the CA business recovery/growth across all three segments, we note that supply chain issue and inflationary pressure would continue to weigh on STE’s margins. Management guided that the group would also continue to incur integration costs of S$10-20m p.a. in the next two years, related to the post-acquisition integration of TransCore.
• Lower 2022-24 core net profit forecasts by 7.4-9.6%. The cuts were mainly due to lower profit forecasts for USS (due to integration costs of TransCore) and DPS (lowered margin assumptions due to inflation pressure), partly offset by higher profit forecast for CA (raised steady-state margin assumptions).
• Risks include negative margin surprises due to project cost overrun and failure to pass down inflationary cost pressure.
• Maintain BUY with a lower DCF-based target price of S$4.40. STE’s current price of S$4.06 implies 2023F core PE 22.4x, or 0.6SD above its historical mean of 21.3x.
SHARE PRICE CATALYST
• Core profitability growth on CA business recovery/growth and higher DPS project deliveries.