SINGAPORE (May 18): The Covid-19 outbreak has hurt the commercial aerospace industry. ST Engineering, with a big chunk of exposure to this industry, is likely to suffer. However, analysts believe the company’s earnings to remain relatively resilient thanks to its defence business.

“Aerospace and Electronics segments will face higher revenue pressure in the near term, owing to larger exposure to commercial customers. The aviation MRO space will be the biggest drag on earnings, as airlines look to defer maintenance spending, flying hours are reduced and new aircraft deliveries slow down. Taking this into consideration, we cut FY20/21 earnings by 16% and 18% respectively,” say Suvro Sakar and Jason Sum of DBS Group Research. 

ST Engineering saw a promising 1Q20 as it ended with a record-high order book of $16.3 billion worth of new contracts -- a sharp increase from the $15.3 billion at the end of 4Q19. Still, with the company set to face the full brunt of the Covid-19 recession in the coming quarters, Sakar and Sum reckon that the new order run rate could slow down going forward, with management anticipating a 5-15% reduction in topline for FY20. CGS-CIMB analyst Lim Siew Khee, on other hand, expects a smaller 3% y-o-y dip.

“[ST Engineering’s] Electronics business has witnessed delays in delivery schedules while there was reduced demand for its Satcom business. For Aerospace, MRO capacity utilisation declined to 80-85% in 1Q20. This is expected to drop to 60%-65% in the coming quarters. Production of aircraft engine nacelle components at Middle River Aerostructure Systems has declined, while passenger to freighter conversions are impacted by supply chain disruptions,” comments Shekhar Jaiswal of RHB Research.

Nevertheless, aerospace earnings will likely be held steady by ST Engineering’s exposure to the domestic and cargo aviation sectors. With customers from countries with vast domestic aviation markets like the US and China, Sakar and Sum anticipate that demand will recover much quicker than international aviation, with no aircraft repair, maintenance and overhaul (MRO) having been cancelled as yet. Cargo aviation has also not been as significantly affected as passenger carriers, with demand from large clients like UPS likely to remain stable. 

With earnings set to decline by 16% and 18% respectively in FY20 and FY21, Sakar and Sum have downgraded ST Engineering from “buy” to “hold”. Target price has also been reduced from $4.60 to $3.40 with a 3% upside to factor in these earning cuts. Nevertheless, they acknowledged that ST Engineering’s earning decline still outperformed other industry peers. 

Much of this resilience has arisen from ST Engineering’s significant exposure to the defence industry (30-35% of its revenue), which has been deemed an “essential service” by the Singapore government. Jaiswal notes that the long gestation period of the industry and broad product base means that the business is expected to remain steady in 2020. The firm will also ramp up the supply of Hunter Armoured Fighting Vehicle (HAV) under Phase 1 (2-3 years) of a contract with the Singapore Ministry of Defense, with a Phase 2 contract already secured. 

Entering the crisis with a strong balance sheet, further implementation of cost-cutting measures combined with government support places ST Engineering in a robust financial position. With an estimated gearing ratio of just 0.7 times for FY2020, AAA credit rating and strong access to capital markets, Sakar and Sum anticipate that the firm is in a good position to capitalise on M&A opportunities in the case of market consolidation - a good source of inorganic growth for the company. 

Strict cost-cutting measures like a 10-15% management pay cut and a reduction in foreign workforce, on top of a $100 million Job Support Scheme Package from the Singapore government will further insulate the company from potential shocks going forward. Unprecedented government stimulus program in the countries that ST Engineering operates in will also help maintain stable revenues as the Covid-19 pandemic continues. 

“STE recently successfully issued a 5-year US$750m note at a 1.5% coupon, which is the lowest coupon ever recorded by a Singapore corporation at that tenure. The issue was more than 8 times oversubscribed, which is testament to STE’s strong access to the capital markets. Additionally, we believe that STE’s strong balance sheet and retained earnings buffer should enable it to sustain its dividend payout on an absolute basis (15 Scts per share) in FY20,” say the analysts. Dividend yield is predicted to be 4.5-4.6% in 2020. 

Going forward, ST Engineering will benefit from ST Aerospace’s continued adventures into new markets by venturing into component original equipment manufacturing via its recently-acquiredUS-based nacelle systems provider MRA Systems. It has also signed a partnership with Airbus to convert A320/A321 and A330 jets and participate in component manufacturing, cabin interior service solutions and aircraft and engine leasing. ST Engineering also hopes to double its $1 billion smart city revenues by 2022 via its other recent acquisition, the satellite communications firm Newtec. 

In light of this promising outlook, Jaiswal predicts that ST Engineering will return to earnings growth in 2020-21 amid a gradual recovery of domestic aviation in the US and China as well as supply chain normalisation in most business segments. He maintains RHB’s “buy call” albeit with a reduced target price of $3.90 from $4.15 with a 19% upside. Lim, on the other hand, is more optimistic, maintaining her “add” call as well as her $3.86 target price with 16.7% upside. 

As of 3.30pm, ST Engineering is trading at $3.28 with a price-to-earnings (P/E) ratio of 17.81 and a dividend yield of 4.57%.