Satcom weakness to weigh on near-term profits
- 3Q23 revenue topped expectations slightly
- Trim FY23F net profit by 1.3% as satcom division to weigh on near-term profits
- Earnings momentum to accelerate from FY24F across all segments
- Maintain BUY with higher TP of S$4.50
Slightly better-than-expected top line growth. Group revenue came in at S$2.43bn (-5.5% q-o-q, +13.0% y-o-y), with 9MFY23 revenue of S$7.3bn representing 75% of the street’s full-year estimate, marginally exceeding expectations. Growth was seen across all three segments, with the commercial aerospace segment achieving the strongest growth of 26.5% y-o-y to S$982m in 3QFY23, propelled by growth in both MRO and OEM businesses. The urban solutions and satcom division also registered healthy top-line growth of 12.5% y-o-y, driven by inorganic growth from TransCore, but offset from sustained softness in its satcom business. Meanwhile, the defence and public security segment booked a modest gain of 2.2% y-o-y.
Orderbook remained near its peak with 3Q23 contract wins of S$2.2bn. STE experienced a slight decrease in its order book to S$27.5bn as of September 2023, down from S$27.7bn in the previous quarter, reflecting a return to normalcy following an exceptionally strong first half of the year. Management has guided for S$2.5bn to be executed from the order book in 4Q23, which signals potential for exceeding the consensus’ full-year revenue forecast of S$9.8bn, especially considering the high likelihood of additional spot work during the period.
Commercial aerospace segment poised for further growth as air traffic continues to rebound. While STE’s hangars have been operating at maximum capacity for some time, several new hangars are scheduled to come online in the next few years, including one in Guangzhou in 1Q24, and others in Ezhou and Changi Creek in 2025, as well as Pensacola in 2025-2026. Unfortunately, the issues with P&W GTF engines are unlikely to result in significant additional work for STE. However, utilisation for the group’s engine and component shops should continue to increase as air traffic volumes grow. STE’s OEM business is also performing in line with expectations, as the group scales up nacelle production to meet Airbus’s requirements. Management has indicated that segment margins are improving due to greater economies of scale, and its passenger-to-freighter conversion program is on track to turn EBIT positive this year and may achieve a mid-to-high single-digit margin by next year. Nonetheless, competitive pricing and inflationary pressures, affecting both labor and the supply of parts and components, continue to pose challenges for margin enhancement.
Urban solutions & satcom (USS) division to achieve lower EBIT compared to FY22 due to satcom weakness. TransCore’s New York Congestion project is progressing well, and remains on track to become earnings accretive in FY24F. Nevertheless, STE has revised its EBIT forecast for this segment, expecting it to remain profitable but at a lower level than in 2022 due to ongoing challenges in the satcom business. Management has noted that revenue growth in satcom has fallen short of expectations, which they attribute to an unpredictable demand landscape. Additionally, the group is still actively pursuing restructuring and transformation of the business to maximise efficiency and reduce costs.
More international defence wins on the horizon? The group has secured international defence contract wins of c.S$250m in 9M2023, and continues to see numerous opportunities as more countries look to raise their defence spending in light of recent geopolitical tensions. In particular, management has observed a trend of customers seeking to bolster their defence inventories, a need amplified by the ongoing strain on supply chains.
Trim FY23F net profit estimate; raise TP to S$4.50. We revise our FY23F net profit estimates down marginally by 1.3% to account for near-term weakness in STE’s satcom division. Nonetheless, we’re increasing our target price to S$4.50 following an update of our discounted cash flow assumptions. STE’s shares have dipped by 5.5% from their peak in 2023, presenting a favourable opportunity for entry. With STE shifting into a higher earnings growth trajectory in FY24-25F—with net profits expected to surge by approximately 15-20% compared to 3-5% in FY23F—the stock is at an inflection point for a breakout, in our view.