SINGAPORE Technologies Engineering : S63 -1.08% (ST Engineering) on Wednesday (May 17) announced that its commercial aerospace business and SF Airlines &ndash a Chinese cargo airline &ndash have incorporated a new joint-venture company in Ezhou, in China&rsquo s Hubei province.

 

The company will operate a greenfield airframe facility at the Ezhou Huahu Airport to provide airframe maintenance, repair and overhaul (MRO) services to cargo and passenger airlines operating in Asia, including SF Airlines.

 

The first hangar facility is slated to be ready in 2025, ST Engineering said. 

 

The joint-venture company was set up with a registered capital of 100 million yuan (S$19 million). ST Engineering holds a 60 per cent stake in the company, and SF Airlines, the remaining 40 per cent. 

 

Jeffrey Lam, ST Engineering&rsquo s president of commercial aerospace, said China will be a &ldquo strong growth driver&rdquo for Asia&rsquo s commercial aerospace sector over the next decade. 

 

&ldquo A presence in Hubei, China, will enhance our MRO network in Asia to better meet and capture the rising regional demand, while our strategic collaboration with an airline partner will enable us to start up a greenfield operation quickly,&rdquo he added.  

 

The setup of this joint-venture company is not expected to have a material impact on the consolidated net tangible assets per share and earnings per share of ST Engineering for the current financial year. 

 

ST ENGINEERING : S63 -0.82%on Monday (May 15) reported revenue of S$2.3 billion for the first quarter, up 13 per cent from S$2 billion the previous year.

 

In a business update, the defence and engineering group said its topline growth came as revenue in most business segments booked improvements over the quarter, and from contributions from transportation solutions provider TransCore, which it acquired in 2022.

 

Its board has approved a Q1 interim dividend of S$0.04 per share, which will be paid out on Jun 6.

 

Revenue from the urban solutions and satellite communications segment rose 46 per cent to S$434 million from S$297 million the previous year, following higher TransCore project deliveries.

 

But the segment&rsquo s revenue growth for the first quarter was affected by supply chain disruptions and project delays, the group noted.

 

Its commercial aerospace business posted a 29 per cent on-year increase in revenue to S$873 million from S$674 million in Q1 2022, attributed to the recovery of the aviation sector as borders reopened.

 

The group noted that its Q1 2023 revenue for the segment was higher than pre-Covid levels, as air travel recovered to more than 80 per cent of pre-Covid levels in January and February 2023.

 

Domestic travel reached near full recovery at 97 per cent, while international travel stood at 78 per cent, said the group. As China reopens, ST Engineering expects more growth in its commercial aerospace sector.

 

The group added that narrow-body aircraft production is expected to be strong over the next 10 years. ST Engineering manufactures nacelles for Airbus&rsquo A320neo fleet, which is projected to see growth. (*see amendment note)

 

Defence and public security revenue fell 8 per cent to S$982 million, from S$1.1 billion in Q1 2022. Excluding Q1 2022 revenue from the group&rsquo s US marine business, the segment&rsquo s revenue was up 1 per cent from S$968 million.

 

In November last year, the group proposed to divest all of its US marine subsidiaries &ndash VT Halter Marine and ST Engineering Halter Marine and Offshore &ndash to Bollinger Shipyards Lockport for US$15 million.

 

The group said a total of S$4.9 billion worth of new contracts was secured over Q1, with defence and public security registering the highest value of deals at S$3.3 billion. Urban solutions and satellite communications won S$823 million worth of contracts, while commercial aerospace won S$747 million worth.

 

ST Engineering&rsquo s order book stood at S$25.4 billion as at end-March. The group expects S$5.8 billion worth of contracts to be delivered over the rest of 2023.

RHB Bank Singapore' s Shekhar Jaiswal continues to call ST Engineering S63 -0.55% a " buy" , citing the defence and engineering conglomerate' s combination of defensive yield and strong earnings growth, which makes this a " special investment opportunity" .

 

However, because of revised financing costs assumptions, which will therefore weigh down earnings forecast slightly by 2%, Jaiswal, in his May 9 note, has trimmed his target price from $4.10 to $4.05.

 

According to Jaiswal, ST Engineering will see potential upside from its commercial aerospace segment, on the back of a recovery in global aviation traffic.

 

Its urban solutions segment will see " strong growth" from Transcore, its US-based traffic management systems unit.

 

In addition, the defence segment will benefit from higher spending in Singapore and in the US.

 

Jaiswal acknowledges that investors are worried about the company' s debt load, incurred to fund the acquisition of Transcore.

 

Nonetheless, he believes the concerns should be allayed by the company' s capacity to produce a significant free cash flow.

 

He expects a " gradual" drop in the company' s gearing from the current FY2023 to FY2025.

 

" We think that Moody' s recent reinforcement of its AAA issuer rating &ndash the highest rating level offered by the credit rating agency &ndash should allay investor worries about ST Engineering' s elevated debt levels," writes Jaiswal.

 

SINGAPORE&rsquo S Land Transport Authority (LTA) awarded a S$200 million contract to ST Engineering : S63 -0.28%&rsquo s Urban Solutions to work on two key systems for the Cross Island Line (CRL).

 

On Friday (Apr 14), LTA announced that Urban Solutions will design and build the integrated supervisory control system for the CRL. It will also do so for the line&rsquo s communications system, which comprises various sub-systems such as the communication backbone network and video surveillance.

 

ST Engineering is expected to start work in the second quarter of 2023.

 

The authority said it awarded the contract to ST Engineering for its cost competitiveness, expertise and track record, as well as the quality of the solutions it proposed.

 

Urban Solutions previously completed the communications systems for four other railway lines, as well as the integrated supervisory control systems for the Circle Line and Downtown Line.

 

LTA also awarded a S$450 million contract to Siemens Mobility to build the CRL&rsquo s signalling and platform screen door systems.

 

The CRL is Singapore&rsquo s eighth Mass Rapid Transit line. It will serve existing and future developments in the eastern, north-eastern and western parts of Singapore, linking major hubs such as the Jurong Lake District, Punggol Digital District and Changi.

For years, Singapore Technologies Engineering (ST Engineering) S63 -0.27% &mdash which started as an arms contractor for the Singapore military &mdash has been actively growing its commercial business across the world for a more diversified revenue base.

 

Yet, it is this long-time customer back home who will, now and then, help lift the company&rsquo s earnings with yet another big contract.

 

On March 27, ST Engineering announced that the Ministry of Defence had tasked the company to help build a fleet of six warships. As per normal practice, neither ST Engineering nor the government would disclose the value of such contracts.

 

Specifically, ST Engineering&rsquo s subsidiary &mdash ST Marine &mdash is to help design and build six so-called Multi-Role Combat Vessels (MRCVs) for the Republic of Singapore Navy. The vessels will be delivered progressively from 2028.

 

ST Marine will also provide logistics support when the MRCVs are operating. The new MRCVs, to be fitted with advanced digital capabilities, will replace the ageing Victory-class Missile Corvettes (MCVs), in service since 1989.

 

CGS-CIMB analysts Lim Siew Khee and Kenneth Tan, in their March 27 note, estimate ST Marine&rsquo s share of contract price per vessel to be between $250 million and $300 million. This means the contract will likely be valued at between $1.5 billion and $1.8 billion, potentially lifting ST Engineering&rsquo s order book to $25 million.

 

The CGS-CIMB analysts base their estimate against ST Marine&rsquo s previous patrol vessels contract awarded in 2012 by Oman Navy at $880 million, or $220 million each. &ldquo We also draw reference from the Abu Dhabi Ship Building contract from the UAE Ministry of Defence in May 2021 to build four Falaj 3-class Offshore Patrol Vessels at US$950 million ($1.2 billion each).&rdquo

 

&lsquo Good progress&rsquo

 

The navy contract aside, &ldquo all segments&rdquo of ST Engineering are making &ldquo good progress,&rdquo say Lim and Tan, who are keeping their &ldquo add&rdquo call on the stock, along with an unchanged target price of $4.

 

On March 17, ST Engineering announced that its urban solutions and satellite communications business unit won a $430 million turnkey rail service contract from the Kaohsiung City Mass Rapid Transit Bureau for the new Kaohsiung MRT Red Line South Extension.

 

The contract will start in mid-2023 for nine years.

 

This is in addition to its $1.4 billion turnkey contract secured in 2022 for the Kaohsiung MRT Yellow Line.

 

The contract started in 2022 and will last for 10 years.

 

In his report, Suvro Sarkar of DBS Group Research notes that ST Engineering has a long track record of building vessels for the Singapore navy and other customers using its yards here.

 

In contrast, ST Engineering yards in the US were running at a loss but were sold last November to Bollinger Shipyards Lockport for around $21 million. These US entities had bled ST Engineering US$256 million between FY2017 and FY2021.

 

With the MRCVs to be built in Singapore, there will be minimal execution issues, says Sarkar.

 

Relative to his CGS-CIMB counterparts, Sarkar has a more bullish estimate of the contract value, suggesting a range of $3.3 to $4 billion, which, if so, will bring ST Engineering&rsquo s order book to a new peak of more than $2.6 billion.

 

He estimates that ST Engineering will start to enjoy meaningful earnings contributions at a &ldquo conservative margin&rdquo of 5% to 6% from this contract from FY2025 onwards, in the range of $180 million to $240 million in total over the six years or so, or, between $30 million and $40 million a year, which implies an accretion of 5.5% to 7.5% compared to FY2022 earnings.

 

&ldquo If ST Engineering can execute better and achieve net margins of 10% on the contract, the accretion will be even more material at 10% to 12% of current group earnings, which would be a very healthy outcome,&rdquo says Sarkar, who is keeping his &ldquo buy&rdquo call and $4.20 target price.

 

Meanwhile, RHB Group Research analyst Shekhar Jaiswal maintains a &ldquo buy&rdquo and a target price of $4.10, higher than CGS-CIMB&rsquo s fair value. However, based on RHB&rsquo s methodology, Jaiswal&rsquo s target price includes an 8% ESG premium over its original $3.80 fair value.

 

&ldquo We see ST Engineering as a unique play with a defensive yield and upside from strong growth in 2023 to 2025 aided by a revival in global aviation traffic boosting its commercial aerospace segment, the USS segment seeing strong growth amid contributions from the TransCore acquisition, and the Defence Public Security (DPS) segment witnessing benefits from rising defence spending in Singapore,&rdquo writes Jaiswal in his March 28 note.

 

He adds that ST Engineering&rsquo s ability to generate strong free cash flow should alleviate concerns about its elevated debt levels. &ldquo We expect the net debt to equity ratio to gradually decline from 2023 to 2025.&rdquo ST Engineering shares closed at $3.64 on March 30, up 1 cent following the announcement of the MRCV contract wins on March 27.