Factoring in higher interest rates
Aggressive rate hikes likely to negatively impact STE’s commercial paper yield in FY23-24F upon rollover. As of end-1H22, STE had S$2.8bn of CPs.
? We raise our FY23F weighted average interest rate assumption to 2.9% (vs. 2.2% guided by management in 1H22), and cut our FY23-24F EPS by 6-8%.
? STE’s S$23.6bn order book and 18% FY23-24F EPS growth could be key drivers for STE’s share price to a recessionary environment. Maintain Add.
Interest headwinds from aggressive rate hikes
On 21 Sep, the US Federal Reserve raised its key interest rate by 0.75% pt to 3.00- 3.25%, with further hikes expected in 2022-23F. New projections (from economists polled by Reuters) indicate that rates could rise further to 4.25-4.50% by end-2022F, and 4.50- 4.75% by end-2023F. With c.45% of STE’s debt being floating rate borrowings (as at end-1H22), we see further earning downside risks for the group in FY23-24F.
FY23-24F EPS cut by 6-8% to factor in higher rates
We understand that the bulk of STE’s floating rate debt are short-term commercial papers (CP); as at end-1H22, STE’s outstanding CP balance stood at S$2.8bn. We believe CPs will face the brunt of rising rates, as their short durations would be subjected to rollover risks upon maturity. In view of higher rates, we raise our FY23-24F average CP interest rate assumption for STE to c.4.0%. As STE still has US$32m in treasury lock gains (to reduce future bond issuance yields) on its balance sheet, we think it will refinance some of its CPs (c.S$700m) in FY23F by issuing longer-term lower-yield bonds (see Fig. 1). With our new assumptions, our FY23F weighted average interest rate is raised to 2.9% (vs. 2.2% as guided in 1H22) and FY23-24F EPS lowered by 6.2-8.0%.
Can STE defend its defensive position?
We looked at the MSCI Singapore performance over the past 20 years and compared it with STE’s performance during the bad times e.g. Asian Financial Crisis, Global Financial Crisis, Severe Acute Respiratory Syndrome (SARS) and Covid-19 (2020-21) We also added periods when Singapore’s GDP forecast was revised downwards as the market usually underperforms when macro fears flare. During these periods, STE outperformed the index by c.5% in the past 10 years and 9% in the past 20, mainly due to its diversification and balance sheet then. With STE’s net gearing position this cycle, we think the market has a higher expectation for its growth. We expect c.18% EPS growth for FY23-24F, supported by its record-high order book of S$23.6bn and the consolidation of Transcore.
Reiterate Add at lower TP of S$3.95, 4.5% dividend yield
Our blended TP drops to S$3.95 as we raise our risk-free rate and cost of debt numbers to factor in rising rates (Fig. 3). STE currently trades at c.18x FY23F P/E (2 s.d. below 6- year historical mean). Catalysts: lower yield on newly-issued bonds, margin recovery and defence order wins. Downside risks: rising cost pressures and recessionary risks.