ST Engineering: 3Q24 largely in line; FY24/25F estimates intact, raise TP to SGD5.40
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3QFY24 revenue met expectations as strong performance in defence and public security (DPS) segment offsets drag from urban solutions & satcom (USS) division and slowdown in commercial aerospace (CA) segment. STE booked 3QFY24 revenue of SGD2.8bn, with 9MFY24 revenue of SGD8.3bn representing 74.4%/73.9% of DBS/consensus full-year estimates, meeting expectations given that 4Q24 tends to be the strongest quarter for the group in terms of seasonality.
Despite the typical lumpiness in revenue, the DPS division maintained strong momentum and saw a 31% y/y and 2% q/q increase in revenue in 3QFY24 to SGD1,272mn, underpinned by strong growth across all sub-segments. Meanwhile, Commercial Aerospace segmental revenue grew 7% y/y, but dipped 2% q/q to SGD1,054mn during the quarter, largely in line with expectations, as MRO strength likely tempered a slowdown in OEM revenue due to a lack of feedstock for P2F conversions and Airbus delivery delays. However, USS segmental revenue decreased by 5% y/y and 7% q/q to SGD455mn in 3QFY24, with 9MFY24 revenue only up 0.3% y/y.
While STE does not disclose any measure of earnings in its quarterly updates, we note that a positive revenue mix (higher contribution from defence business with 12-13% operating profit margins) suggests that the group’s earnings during the period were likely better than expected, barring any material adverse developments from other segments.
Contract wins slowed to SGD2.2bn in 3QFY24, representing a book-to-bill ratio of 0.8x. Notable contracts included more international sales of unmanned aerial systems, 40mm ammunition and weapon systems, and TransCore clinching a contract with Denver International Airport for a ground transportation system management upgrade. While the group’s orderbook fell by 3.6% q/q to SGD26.9bn, management highlighted that half of the decline can be attributed to a weaker USD, given that c.30% of the backlog is denominated in the currency.
Commercial aerospace highlights:
- P2F revenue growth to slow in the near-term STE’s customers are struggling to source older passenger aircraft for P2F conversions as airlines prolong the useful life of older aircraft to increase capacity amid protracted delivery delays from airframe and engine OEMs. Management expects this to impact P2F conversion cadence over the next year but remains confident in its medium-term target of high single-digit margins and SGD700mn in revenue by 2026. Excess P2F capacity will be allocated to airframe maintenance, though reconfiguration may take time due to different skillset and equipment requirements. Near-term hangar utilisation (~90%) may remain suboptimal as a result.
- Overall airframe and engine MRO demand remains healthy: Management shared that MRO demand continues to be robust, and the group is upbeat on increased CFM heavy maintenance shop visits, as airlines work older aircraft harder. We believe that STE has been relatively less impacted by supply constraints thus far. Furthermore, the group remains on track to expand airframe capacity by c.15-20% (vs current capacity) from 2026 as more hangars become operational over the next few years in various locations. It should take around half a year for these new facilities to get up to operational capacity, but segmental margins should see an uplift from increased operating leverage and the absence of start-up costs.
Urban solutions & satcom highlights:
- Guidance for segment revenue and EBIT to be better than last year maintained: While the c.5% y/y decline in segmental revenue suggests that growth in the urban solutions sub-division may be waning, we believe that part of the deceleration could be ascribed to project delivery timings, such as the completion of EPC milestones for the NY congestion pricing system in 2HFY23 to 1HFY24. Management reiterated that they expect the segment to perform better in terms of revenue and EBIT in FY24F against the previous year, which should alleviate some concerns on a material slowdown in segmental growth.
- Sizable order backlog underpins growth visibility: Given the segment’s substantial order backlog (book-to-bill ratio of 1.6x over the past eleven quarters), we continue to anticipate the segment to see stronger growth over the next few years, aided by a recovery in the satcom business. Furthermore, a massive contract worth USD1.73bn (SGD2.3bn) clinched by TransCore to develop and maintain the E-ZPass toll collection system for the New Jersey Turnpike Authority was also not included in the orderbook for the current period as the contract has yet to be finalised due to formal protests from the incumbent operator, Conduent Inc. Management explained that this contract will cover three years of engineering and construction and eight years of operations and maintenance, and that protests are highly common and will likely take several months to be resolved. Accordingly, this project will drive strong growth in TransCore over the long-term.
Defence and public security highlights:
- Strong growth across all sub-segments: DPS revenue is on track for full-year growth in the teens, with the digital business expected to exceed its SGD500mn 2026 target this year.
- Increased exports driving medium-term growth: Heightened concerns over supply chain integrity and stockpiling of conventional weapons and ammunition are boosting export opportunities, driven by lessons from recent conflicts.
FY24/25F estimates largely unchanged, expect 15-20% earnings CAGR between FY24-26F; maintain BUY with higher TP of SGD5.40. We slightly reduced our CA revenue projections due to softer P2F contributions and moderated margin improvement assumptions to account for suboptimal hangar utilisation and lingering cost concerns. Similarly, USS revenue projections were trimmed to reflect slower growth in 9MFY24. However, stronger DPS growth (12-13% margins vs. 6-8% for CA and 2-4% for USS) offsets these weaknesses. With lower finance costs from deleveraging and lower interest rates, we project core net income to grow at a commendable15-20% CAGR between FY24-26F.
We raise our TP to SGD5.40, shifting our P/E peg to 20x FY25F EPS (from 20x blended FY24/25F) and updating DCF assumptions. The sell-off post-results appears overdone, with CA segment weakness likely short-term and USS weakness linked to project timing. Although order wins decelerated in 3Q24, the group’s order backlog remains robust, and it is premature to suggest this signals the start of a sustained downtrend. More critically, the market seems to have overlooked the continued strength of the DPS segment, which boasts the highest operating margins and remains on a strong growth trajectory. With the group well-positioned to capitalise on and adapt to potential policy changes under the Trump administration, we view the risk-reward proposition as compelling at this juncture. We reiterate our BUY rating, positioning STE as one of our top picks in the aviation sector.
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