ST Engineering — SG’s Tesla
ST Engineering posts a 9% drop in revenue and a 9.7% drop in net profit for FY2020. Nevertheless, I would still recommend an overweight call on the stock.
ST Engineering business is broadly divided in 4 segments: Aerospace, Electronics, Land systems and Marine sector. The Aerospace sector is the largest contributor (about 44%) to group’s revenues, followed by 29% from Electronics sector, 18% from Lands Systems sector and 8% from Marine, according to FY19 results. The Aerospace and Electronics sectors are the major drivers of the group’s earnings.
In the Aerospace segment, they are involved largely in the maintenance, repair and operations (MRO) services for aviation players. These include commercial and government clients. They are also consolidating their offerings in the aerospace manufacturing space, especially in original equipment manufacturing. Other services such as technical services and asset management are also offered under this segment.
In the Electronics segment, they offer ICT products, smart city solutions, and security solutions. Defence, homeland security solutions are main offerings of the Lands Systems segment. Marine sector offers largely shipbuilding, MRO solutions to the maritime players.
One of the reasons for the overweight call on the stock is the strong track record of financial performance. Putting aside the FY20 results, which can be attributed to the effects of the pandemic which affects most of the market, FY2019 results were strongly positive. ROE and TSR increased healthily, driven by earnings growth and order book growth, especially in the aerospace sector.
Looking at the five-year performance of each segment as below, it can be seen that the major sectors of Aerospace and Electronics are steadily growing while the smaller and more volatile segments of Marine and Lands Systems tend to be fluctuating.
Besides past financial performance, there are also strong positive trends that serve as tailwinds for the business.
One of the tailwinds is robust demand for aviation. Putting aside the aberration that is 2020 and probably 2021 where the pandemic has grounded air travel practically, the long-term post-pandemic recovery for the aviation sector look favourable, especially in key Asia markets like India and China with sizeable domestic aviation market. Air travel will revert to its pre-pandemic levels. In fact, given lockdown fatigue, there will be a significant pent-up demand for travel once border restrictions are eased. One may have to wait until 2022 to see the recovery, but it will come. ST Engineering is well-poised to benefit from increased demand for aviation and aerospace services once the recovery happens. This is a good time to buy the stock, given the depressed valuations, if one was looking to hold it for, say, five years.
Increase in global trade will also mean demand for maritime services such as MRO will remain robust. The recent incident in Suez Canal only strengthen proposition of reliable services is maritime rescue operations, which ST Engineering is well poised to provide. Like the Suez Canal, a sizeable proportion of global trade flows through the ports and maritime channels around Singapore, which place ST Marine’s shipyards in good stead to service global maritime players.
Beyond the underlying demand in global trade and aviation, one of the factors that put ST Engineering is positive favour is its efforts in the adoption and commercialisation of technologies of the future. It is moving into high value-added OEM space of aerospace manufacturing. This positions the aerospace division as a global integrated aviation solution provider. It is also looking to consolidate its position in the satellite communication space catering to the increased fleet of Low Earth Orbit (LEO) satellites globally. Its electronics business is looking at autonomous vehicle (AV) commercialisation and wide spread adoption, building on the successful pilot if the Sentosa shuttle bus fleet. It is also looking at robotics adoption to allow the Tuas seaport to have autonomous handling. These are technologies that will drive economies of the future, and the bottom-lines of companies who are catering to that. ST Engineering looks to be a good long-term buy with the technologies that it is looking to adopt and commercialise.
Lastly, the nature of relationship that a company as ST Engineering has with its customers tend to be sticky. ST engineering counts the Singapore military, homeland security, US Navy, Airforce, German Airforce as its customers. These are highly sticky relationships given the sensitive nature of the business and technologies. It also counts the major airline manufacturers as its key customers. There is staying power in this business. ST Engineering is also owned 50% by Temasek. It thus has the backing of a sovereign wealth fund with deep pockets, not to mention the implicit backing of the Singapore Government with such an ownership.
There are some key risk factors that one can identify for this company.
Firstly, this is a high capex business, with long gestation period for projects. This business model does not do well in a listed company structure, with all market pressure on quarterly earnings. This is exacerbated by the fact that aviation, electronics, maritime sectors are inherently cyclical businesses. Stock price of the company can take quite a beating such as in present time. Nevertheless, they also present good entry points when earnings are facing downward pressure and valuations are low, especially when the fundamentals on the business are strong and long-term business prospects remain robust.
This is also a low-margin business. Cost management is crucial to ensure robust and sustained return to shareholders. ST engineering has a strong record of dividend payouts (around 4% dividend yield annually). This should provide comfort to be shareholders.
Lastly, the company can work on improving its management and board diversity. They are made up of largely older Chinese men from similar background. Diversity is no longer a nice to have. It is a business imperative.
