ST Engineering: 2H22 earnings below, but outlook remains bright
- 2H22/ FY22 earnings below expectations as margins dragged by high energy costs
- Revenue continues to climb, driven by sustained recovery in commercial aerospace segment and Transcore contribution
- Orderbook at record level of S$23bn, implies robust book-to-bill of c.2.5x
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For the full-year FY22, revenue was up 17% to S$9.0bn from S$7.7bn in FY21, driven by the Transcore acquisition and recovery in Commercial Aerospace segment. Group EBIT rose 9% y-o-y to S$735.1m in FY22 despite a S$203m reduction in government support. Cost savings and business growth both contributed to the EBIT increase, also aided by pension restructuring, though offset by transaction and integration costs related to Transcore and higher energy costs. FY22 net profit however declined 6% y-o-y to S$535m owing to higher interest expenses to finance the acquisition of Transcore without commensurate earnings contribution.
4Q22 revenue met expectations. The group reported revenue of S$2.5bn in 4Q22 (+12.9% q-o-q, +14.2% y-o-y), with commercial aerospace segment revenue surpassing 1Q20 (pre-COVID19) levels. Revenue contribution from newly acquired TransCore business offset the softness in the satcom business segment, while other sub-segments in the defence and public security division witnessed solid revenue growth amid heightened geopolitical tensions.
Core operating margin narrowed slightly in 2H22. Core EBIT climbed to S$360m (+8.1% h-o-h, +50.6% y-o-y) in 2H22, but margins remained below pre-pandemic levels of 8-9%, due to sticky inflationary pressures, and continued supply chain disruptions (causing shortage of high-end semiconductor chips and RFID chips). Assuming normalised energy prices (STE was especially impacted by the surge in electricity prices during the year), and excluding the adverse impact of chip shortages, core EBIT margins would have been consistent with pre-pandemic levels at c.8.5%. The defence and public security division also bore the drag from the US marine business, which has been divested now.
Segment trends and outlook:
Commercial aerospace:
- Healthy utilisation rate of 80% in 2022 across all MRO facilities
- Airframe hangars are currently fully booked out, driven by business recovery and strong P2F demand.
- At MRAS, nacelle production currently at 50 per month as of end-2022, will increase in tandem with A320neo production.
- Floor panel production business will benefit from the ramp-up in A320neo and A350 production.
- P2F programme turned gross profit margin positive at the programme level at end-2022, should turn EBIT positive sometime in 2023.
- Labour shortage will remain a challenge – will likely see further wage inflation in 2023.
- STE is opening hangar 2 in Pensacola, and in the midst of building two more hangars there.
- STE also announced a JV with SF airlines in China to open up more hangar capacity in China and potentially benefit from the reopening trajectory.
- Momentum continues to be robust in smart city business – demand for mobility, rail and road, and urban solutions continue to be among top priorities for customers, also seeing more opportunities to apply TransCore solutions in Asia.
- Macroeconomic headwinds will continue to weigh on satcom business as STE is seeing delays in projects, with satellite operators deferring purchases
- Meanwhile, chip shortages are expected to still have an adverse impact on the business in 2023.
- Will continue to see S$10m in transaction and integration costs over 2023-2024 related to Transcore.
- Transcore acquisition was not accretive to earnings in FY22, owing to high transaction & integration costs, but we expect it to start contributing to earnings from FY23 onwards.
- Record new orders of S$5.2bn in FY22
- Losses from US marine business was around US$55-60m in FY22, will no longer have this overhang going forward with the divestment of the US marine business.
Impact to financing costs may not be as steep as we had thought earlier. STE’s borrowings increased by more than S$4bn in FY22 to finance the acquisition of Transcore, but the Group saw only marginal increase in weighted average borrowing costs from 2.3% in FY21 to 2.4% in FY22. Current debt funding structure consists of 53% fixed rate and 47% floating rate borrowings respectively. As the debt is repriced amid rising interest rate environment, borrowing costs will increase in FY23, but management indicated that weighted average cost of borrowings will be in the low 3% range in FY23, which is not that prohibitive and lower than our earlier assumptions. The Group plans to convert some of its US commercial paper issues and instead issue US$500m of fixed rate debt with T lock gain amortisation of US$32m in due course.
Given the lower-than-expected margins in 2H22, we cut earnings estimates for FY23/24. We have cut FY23/24 core earnings estimates by around 3%/2%, largely to factor in higher energy expenses. The satcom business in the USS segment will likely continue to see slow growth in 2023, given the global growth slowdown, but other segments are likely to continue growing along expected lines.
Quarterly dividend of 4.0Scts per share, as expected, was announced for 4Q22, as per changes to the dividend policy to quarterly distributions from semi-annual distributions. Full-year DPS of 16.0Scts per share represents a dividend yield of around 4.5% based on current share price levels.
Share price has largely factored in negatives, maintain BUY with revised TP of S$4.20. STE’s share price has recovered from the troughs in November 2022, but still below last year’s highs, owing to the high inflation, higher for longer interest rate scenario coupled with recession risk, given its global revenue exposure (Asia 50%, US 25% and EU 18%). At the current valuation (around -1.5 SD below historical mean), we believe the market is ignoring the potential double-digit earnings growth over FY22-24F, driven by inorganic growth from Transcore plus aviation recovery, and risk-reward remains attractive in our view despite the impact from higher interest rates, which we have already factored in our earnings. Our TP is revised up to S$4.20 as we roll over valuations to FY23 estimates. Maintain BUY.
| FY Dec | 2H2021 | 1H2022 | 2H2022 | % chg yoy | % chg hoh |
|---|---|---|---|---|---|
| Revenue | 4,042 | 4,270 | 4,765 | 17.9 | 11.6 |
| Cost of Goods Sold | (3,251) | (3,421) | (3,915) | 20.4 | 14.5 |
| Gross Profit | 791 | 849 | 850 | 7.5 | 0.1 |
| Other Oper. (Exp)/Inc | (476) | (475) | (508) | 6.7 | 7.0 |
| Operating Profit | 314 | 374 | 341 | 8.7 | (8.6) |
| Other Non Opg (Exp)/Inc | 0.00 | 0.00 | 0.00 | - | - |
| Associates & JV Inc | 4.40 | 10.9 | 22.3 | 407.3 | 104.3 |
| Net Interest (Exp)/Inc | (20.7) | (33.5) | (104) | (402.2) | (211.1) |
| Exceptional Gain/(Loss) | 0.00 | 0.00 | (13.3) | nm | - |
| Pre-tax Profit | 298 | 351 | 246 | (17.3) | (29.8) |
| Tax | (24.4) | (68.7) | 14.6 | (159.8) | (121.2) |
| Minority Interest | 1.03 | (2.39) | (5.93) | nm | 147.7 |
| Net Profit | 274 | 280 | 255 | (7.1) | (8.9) |
| Net profit bef Except. | 274 | 280 | 268 | (2.2) | (4.2) |
| EBITDA | 507 | 612 | 653 | 28.8 | 6.7 |
| Margins | |||||
| Gross Margins (%) | 19.6 | 19.9 | 17.8 | ||
| Opg Profit Margins (%) | 7.8 | 8.8 | 7.2 | ||
| Net Profit Margins (%) | 6.8 | 6.6 | 5.4 |
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