FY23 results slightly above expectations with TransCore turning earnings accretive ahead of guidance; raise TP to S$4.80
- FY23 core net profit of S$610m topped our estimate by 2%
- Core operating margin improved to 8.2% in 2H23, up from 7.0% last year
- Expect STE’s growth trajectory to accelerate from FY24F, propelled by growth across all business segments
- Earnings estimates remain intact; maintain BUY with higher TP of S$4.80
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Full-year revenue increased by 12% to S$10.1bn, surpassing our forecast by 2%. The growth was largely fuelled by TransCore's contribution (which began in 2QFY23) and robust momentum in STE’s commercial aerospace (CA) segment, aligning with global air traffic rebound and an uptick in nacelle and P2F conversions. Despite flat y-o-y revenue, the Defence and Public Security (DPS) segment grew 6%, excluding the divested US marine business, with Digital Systems reporting an impressive 11% y-o-y growth. Meanwhile, the group’s ex-TransCore Urban Solutions sub-segment likely experienced flat to marginal growth during the year, while its Satcom business continued to struggle amidst industry headwinds.
Core operating margin improved to 8.7% in FY23, up from 6.9% in FY22, though margin growth in the CA segment was slightly below expectations. Excluding the noise from TransCore transaction and integration costs, the loss on the divestment of Satixfy, and Satcom severance losses, there was generally margin improvement across all business segments. The margin in the group’s DPS segment was notably strong, achieving a double-digit margin for FY23, a 4% increase from the previous year, bolstered by the absence of US marine losses, cost-cutting initiatives, and a favourable project margin mix. The core operating margin in the commercial aerospace segment rose to 7.2% in FY23, up from 6.6% the previous year, though we had anticipated more significant gains from economies of scale and OEM business activities. Management indicated that investments in tooling for new capabilities and labour cost pressures in the US have impeded margin improvement. While STE’s Urban Solutions & Satcom (USS) segment witnessed a dip in core operating margin to 3.1% in FY23 (vs. 3.3% last year), performance improved in 2HFY23, achieving a core operating margin of 5.2% vs 0.5% in 1HFY23, driven by a stronger contribution from TransCore.
We project the group’s revenue and net profits to grow at a robust 6% and 16% CAGR, respectively, between FY23-25F, backed by a solid order book (S$27.4bn as of Dec ‘23), with growth stemming across all sectors.
Commercial Aerospace: The CA segment is set for stronger revenue growth alongside increasing global air traffic and expansion in P2F conversion capacity as more sites become operational, and nacelle production increases with Airbus’s ramp-up of A320neo production. Airframe MRO capacity (measured in man-hours), currently 5-10% above 2019 levels, is expected to surge by 30% in the next few years as the group adds more hangars in various locations.
We anticipate a modest margin expansion over the next two years as the P2F business is expected to see margin improvement to mid-single-digits in 2024 and high-single-digits in 2025, coupled with greater operating leverage and enhanced pricing power due to the tight market.
Urban Solutions & Satcom: We foresee a moderate recovery in the group’s satcom business (after two years of decline) and continued revenue growth in its urban solutions segment over the next few years, driven by increased project deliveries. STE has secured multiple contracts in this segment over the past two years, including:
- A contract to build a multimodal intelligent transportation central platform in Abu Dhabi and provide platform screen doors across multiple global sites.
- A turnkey rail contract for Kaohsiung’s Yellow Line, and a contract for the Kaohsiung MRT Red Line extension.
- A contract to build an integrated supervisory control system and communications system for the Cross Island Line for LTA.
- A substantial contract to implement smart car park technology at the Dubai Mall, one of the largest shopping centres in the world with over 13,000 parking spaces.
- Beyond its congestion pricing project in the US, TransCore is eyeing multiple opportunities in Southeast Asia, targeting congested cities like Manila, Bangkok, and Kuala Lumpur for its tolling solutions.
Defence & Public Security: The DPS segment is also expected to see healthy top-line growth, thanks to the strong momentum in contract wins within the segment (S$7.7bn worth of contracts clinched in FY23, including S$950m of international defence contracts). Management has shared that they are currently working on several major projects at this juncture and hope to share more good news on this front. Additionally, the digital business, which achieved revenue of S$463m (a 20% y-o-y increase) in FY23, is well-positioned for further growth given the robust demand in this segment and its recent acquisition of D’Crypt. Management is optimistic that current margin levels can be maintained.
Increase in finance costs likely to be moderate in FY24F. Management has maintained its guidance for an all-in finance cost in the mid-3% range, assuming no Fed rate cuts in 2024, up marginally from 3.3% in FY23. Given a lower debt balance this year, which is likely to decrease further in 2024, the increase in interest costs this year should be manageable, with a minor upside if the Federal Reserve were to cut interest rates later this year.
Full-year dividend per share of 16.0 Scts (approximately 4.0% dividend yield) remains unchanged and is likely to stay flat for the foreseeable future as growth and debt reduction take priority. Management has indicated that they are still open to mergers and acquisition opportunities to drive growth and will likely focus on reducing debt rather than increasing dividends with incremental cash flows.
We raise our FY24/25F revenue forecasts by 3-4%, but our net profit estimates remain unchanged; we maintain BUY with a higher TP of S$4.80. We adjusted our revenue estimates upward by 3-4% to reflect the strong business momentum across the group’s divisions. However, our net profit estimates remain unchanged as we anticipate slower margin improvement in the group’s commercial aerospace segments due to lingering cost headwinds. Our TP increased to S$4.80 as we roll forward our valuation peg to 21.0x P/E (FY24F) from 21.5x (blended FY23/24F) previously and update our DCF assumptions. The current risk-to-reward setup is favourable, in our view – STE’s stock is currently trading at 18.2x on a forward P/E basis, c.1SD below its five-year average, an inconsistency with its promising earnings growth trajectory (16% CAGR between FY23-25F).
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