SINGAPORE (Dec 26): Capital goods – which are used in producing other goods, rather than being bought by consumers – are on the cusp of a “strong recovery” in earnings growth, market watchers say.

CGS-CIMB Research and RHB Group Research both have “overweight” ratings on the capital goods sector.

Notably, RHB has “buy” calls on all six capital goods counters under its coverage, including the three large-cap offshore and marine (O&M) stocks.

In particular, RHB lead analyst Leng Seng Choon favours Keppel Corporation as the top O&M pick.

“For Keppel Corp, the re-rating catalyst is Temasek's partial share offer, which is also a precursor to an impending business restructuring, particularly of its O&M arm,” says Leng.

Temasek Holdings in October announced it is moving to increase its stake in Keppel Corp to 51%, and undertake a “comprehensive strategic review” of its businesses. While the sovereign wealth fund says it intends for Keppel to remain listed on the Singapore Exchange (SGX), it added that it will work with the board of directors of Keppel to undertake a comprehensive strategic review of its businesses with the objective of creating sustainable value for the conglomerate’s shareholders.

See: Temasek moves to raise stake in Keppel Corp to 51% with partial offer at $7.35 per share

“Keppel Corp’s O&M business has secured $1.9 billion worth of orders in 2019 (ahead of 12M18’s $1.7 billion), with LNG and renewable-related projects accounting for close to 60% of order wins,” Leng notes, adding that the group has a “diversified asset structure with huge value-unlocking potential”.

RHB has a “buy” call on Keppel Corp with a target price of $7.80.

As at 3.15pm, shares in Keppel Corp are trading at $6.73, up 14.8% year-to-date.

Meanwhile, CGS-CIMB lead analyst Lim Siew Khee highlights another Temasek-linked group to watch: Sembcorp Industries (SCI).

“Despite severe losses at Sembcorp Marine (SMM), SCI has been generating profits as a group, lifted by the energy division, which had beaten our expectations over the past two quarters,” Lim says.

The analyst notes that SCI is trading at a 10-year trough, at a price-to-book value (P/BV) of just 0.6 times for CY19F.

“The success of Temasek’s partial offer for Keppel Corp could pave the way for restructuring between SCI and SMM,” Lim adds.

CGS-CIMB has an “add” recommendation on SCI with a target price of $2.78.

As at 3.25pm, shares in SCI are trading at $2.27, down 9.6% year-to-date.

Another “cheapest” name that Lim identifies with the capital goods sector is Yangzijiang Shipbuilding (YZJ), which is trading at a 5-year trough.

“We think YZJ’s share price weakness is due to market concerns over the absence of leave by its executive chairman, Ren Yuanlin, who is assisting in a confidential investigation by certain China government authorities,” Lim says.

YZJ announced earlier this week that Ren will resume work with effect from Dec 23.

See: Yangzijiang's Ren to resume work after assisting with graft probe

While further details on the investigation and the return of YZJ’s key man are scant, market watchers are largely positive on the latest development.

“We think his return is the key catalyst for the stock,” says Lim.

CGS-CIMB has an “add” recommendation on YZJ with a target price of $1.45.

Shares in YZJ, which had rebounded following the news of Ren’s return, are currently trading at $1.13, down 9.6% year-to-date.

Over in the aerospace subsector, CGS-CIMB has a high-conviction “add” call on SIA Engineering (SIAEC) while RHB names ST Engineering (STE) as its top pick.

"Transformation efforts are paying off for SIAEC as its EBITDA margin rose for the fifth quarter in a row in its recent 2Q3/FY20 results,” says CGS-CIMB’s Lim. “We like SIAEC for its M&A angle, margin expansion, decent yield of 4% and strong net cash pile of $488 million.”

CGS-CIMB has an “add” call on SIAEC with a target price of $3.30.

As at 3.44pm, shares in SIAEC are trading at $2.82, up 24.8% year-to-date.

Meanwhile, RHB believe ST Engineering should continue to outperform in 2020.

“ST Engineering’s double-digit profit growth outlook for 2020-2021, record-high orderbook with more than two years of revenue visibility, positive FCF generation capability, reasonable dividend yield and ability to undertake earnings-accretive acquisitions led it to outperform the Straits Times Index by 7.1% in 2019,” notes analyst Shekhar Jaiswal.

“STE remains one of our sector and country top picks, with earnings contribution from the Newtec acquisition and continuing strong order wins as key re-rating catalysts,” he adds.

RHB has a “buy” call on ST Engineering with a target price of $4.55.

As at 3.48pm, share in ST Engineering are trading at $3.92, up 12% year-to-date.

On the small caps front, CGS-CIMB names CSE Global as its top pick.

“We are still excited about CSE Global’s forward earnings growth potential, especially given its padded order backlog,” says analyst Cezzane See. “We think CSE could end FY19F with an order backlog of at least $300 million – the highest order backlog in the past five years.”

In addition, she notes that, despite bringing CSE to a net debt position, CSE’s acquisitions this year have either been earnings accretive or have widened its regional reach.

The brokerage has an “add” rating on CSE with a target price of 73 cents.

As at 3.52pm, shares in CSE Global are trading at 54.5 cents, up 41.6% year-to-date.