Hurt during the pandemic, Singapore Technologies Engineering S63 0.78% (ST Engineering) is now bolstering its commercial aerospace division to seize not just opportunities from the industry&rsquo s recovery, but also long-term growth.

 

&ldquo Our business model is based on investments of 20 years and beyond,&rdquo says Jeffrey Lam, president of commercial aerospace at ST Engineering, on Sept 23, when the company held the groundbreaking of a new $170 million Changi Creek airframe maintenance, repair and overhaul (MRO) facility. &ldquo Heavy infrastructure investments tend to be long-term, and therefore, a decision like this to us is not just a short-term affair,&rdquo he adds.

 

If Lam can have his way, the commercial aerospace market will be one to stay in. &ldquo We think of factors that run in the long term, such as government support and political stability. So we believe that it is with this approach that our business has continued to deliver good, positive returns.&rdquo

 

For the company&rsquo s 1HFY2023 ended June, the commercial aerospace segment contributed more than $1.8 billion in revenue, up 32% y-o-y. Its ebit, meanwhile, was up 60% y-o-y in the same period. The revenue contributed by commercial aerospace makes it a close second to ST Engineering&rsquo s original core business of defence and public security, which generated $2.1 billion in sales.

 

The new 84,000 sq m (about 904,200 sq ft) facility at Changi Creek, at the northern end of Changi Airport&rsquo s runway, will have four hangar bays. The first hangar will be ready in mid-2025, with the remaining three primed for service by 2026. The facility can service widebody aircraft, and will also include a hybrid paint and maintenance bay.

 

See also: CGS-CIMB appoints veteran economist Song Seng Wun as economic advisor

 

Lam points out that the new facility looks to build upon, not replace, ST Engineering&rsquo s existing MRO infrastructure in Singapore.

 

&ldquo Rather, our intent is to attract more customers and workload here [to Singapore] to signal growth,&rdquo he says.

 

As the world&rsquo s largest third-party MRO service provider, ST Engineering is already running numerous hangar facilities worldwide. Besides Changi, there are facilities in Paya Lebar and Seletar. ST Engineering also operates this business in Dresden, Germany Guangzhou and Shanghai in China Mobile, Pensacola and San Antonio in the US.

 

ST Engineering can work on up to 44 widebody, 26 narrowbody and 24 general aviation aircraft across this global network at any time. Once fully operational, the Changi Creek facility will provide an extra 1.3 million man-hours annually, roughly equivalent to 10% of ST Engineering&rsquo s existing global airframe MRO capacity.

 

In pursuing sustainability, Changi Creek is integrating green technology by installing solar panels on its hangar roof. Equally significant is the implementation of advanced equipment and systems, including automated guided vehicles and digital tools, to facilitate paperless operations. &ldquo In terms of their ability to handle an aircraft&rsquo s shape and form, these facilities don&rsquo t change much.

 

So ultimately, it comes down to the software, where there are many tools to help manage workload and certain situations,&rdquo Lam explains.

 

&ldquo During the pandemic, we had segregation among different processes, which was all assisted by software. So certainly, we want a facility that&rsquo s good for the next generation, with more IT tools, more green fea-

tures. And of course, it means more ability to take customers in,&rdquo he adds.

 

Once operational, Changi Creek will generate over 550 jobs, spanning aircraft engineers, planning and production control experts, mechanics, and warehouse and logistics staff. Besides new hires, certain positions at the new facility would possibly be filled by transferring employees, especially those holding supervisory positions, from other MRO facilities due to their existing knowledge, says Lam.

 

To build a steady pipeline of potential hires, ST Engineering is already running various programmes with institutions in Singapore to source skilled local workers, but in the absence of this, contract work from workers overseas will also be looked at, says Lam.

 

MRO contract wins

 

The establishment of the Changi Creek facility comes about befittingly. According to an industry report by Oliver Wyman&rsquo s Global Fleet and MRO forecast for 2022 to 2023, fleet growth and MRO demand in the Asia Pacific region look projected to increase at CAGRs of 2.5% and 1.8% respectively over the next decade.

 

To add further buzz, in the few days following the groundbreaking on Sept 23, ST Engineering quickly announced related MRO contract wins from two customers, Indonesia&rsquo s Lion Air Group and Japan Airlines.

 

With Lion Air Group, a five-year contract has been signed to provide MRO services for the group&rsquo s existing Boeing 737 MAX aircraft fleet under its carriers, including Lion Air, Batik Air, Batik Air Malaysia and Thai Lion.

 

Similarly, ST Engineering has secured a multi-year contract to provide Japan Airlines with component maintenance-by-the-hour and other related services.

 

On Sept 27, ST Engineering announced a collaboration with Quickstep Holdings, Australia&rsquo s largest independent aerospace engineering company. Under the terms of this partnership, the two companies will establish a regional nacelle pool in Australia, supporting both Boeing and Airbus aircraft.

 

Nacelles are the critical structures holding aircraft engines to the wings.

 

Quickstep will assume responsibility for the day-to-day operations via its facilities in Sydney and Melbourne. On the other hand, ST Engineering will leverage its MRO expertise in nacelles and aerostructures to provide engineering support.

 

&lsquo Room to grow&rsquo

Analysts generally hold a positive view of ST Engineering&rsquo s commercial aerospace business. Changi Creek will be a further boost. &ldquo This expansion should support earnings growth of its commercial aerospace segment, backed by the recovery of international aviation traffic,&rdquo writes RHB Bank Singapore analyst Sheikhar Jaiswal in his Sept 25 note, where he has kept his &ldquo buy&rdquo call and $4.50 target price on this stock.

 

The team at OCBC Investment Research, which has a &ldquo buy&rdquo call and a $4.45 target price, shares this view. &ldquo Having surpassed pre-pandemic revenue levels in 1HFY2023, commercial aerospace is well-positioned to capitalise on the last leg of recovery, with its strategic hangar capacity expansion supporting higher MRO demand from the resumption of China&rsquo s outbound tourism in full,&rdquo says OCBC in its Sept 15 report.

 

Peggy Mak of PhillipCapital notes that total contract wins by ST Engineering&rsquo s commercial aerospace unit in 1HFY2023 hit $3 billion, of which $2.3 billion were secured in 2QFY2023 alone, pointing to strong underlying demand.

 

Next, citing figures from the International Air Transport Association, Mak points out that global air passenger-km in the first half of this year was still 9.7% below the pre-Covid-19 level in 1H2019. Asia Pacific, the last region to re-open, lagged at 20.3% lower than 1H2019&rsquo s level. &ldquo There is, therefore, room for MRO demand to grow,&rdquo writes Mak in her report on Sept 26, as she initiated coverage on the stock with a &ldquo buy&rdquo call and

$4.50 target price.

 

Besides commercial aerospace, analysts have a broadly favourable perspective on the company&rsquo s two other big business segments: the urban solutions and SatCom (USS) sector, and its defence and public

security sector.

 

In this era of heightened geopolitical tension, defence spending is rising again worldwide, Singapore included. In FY2021 and FY2022, Singapore&rsquo s defence and security spending increased by 12% and 17%, respectively. &ldquo This is expected to rise further, providing revenue visibility for ST Engineering,&rdquo says Mak, noting that total defence and security contracts won by ST Engineering amounted to $5.2 billion in 1H2023, 20.9% higher than the whole of FY2022, and thereby contributing to the company&rsquo s record order book of more than $27 billion.

 

ST Engineering&rsquo s acquisition of US-based traffic systems provider TransCore should start to pay off too, along with more new contracts. &ldquo TransCore&rsquo s acquisition is on track to be earnings-accretive from 2HFY2023, we believe, leading to positive FY2023 earnings before interest and taxes (ebit) for the USS division,&rdquo says Mak.

 

PhilipCapital analyst Peggy Mak has initiated a &ldquo buy&rdquo call on Singapore Technologies Engineering S63 0.26% (ST Engineering) with a target price of $4.50. The analyst&rsquo s target price is based on a discounted cash flow model (DCF) valuation, and she expects a return on equity (ROE) and return on invested capital (ROIC) of 26.1% and 14.6% respectively in FY2024.

 

Amidst heightened geopolitical tensions and cybersecurity threats, Singapore has expanded its defence and security spending by 12% y-o-y in FY2021 and 17% in FY2022, which well exceeds the 4% average annual growth in the area from FY2010 to FY2020. In FY2023, this average annual growth is expected to rise to 6%, says Mak.

 

&ldquo As a key Singapore defence contractor, ST Engineering&rsquo s defence and public security (DPS) sector will enjoy revenue visibility as more contracts are awarded,&rdquo she adds.

 

In 1HFY2023 ended June 30, ST Engineering won $5.2 billion in new orders for defence and security work, which is 20.9% higher than in FY2022.

 

On the company&rsquo s commercial aerospace (CA) sector, the recovery in air travel will underpin demand for aerospace maintenance, repair and overhaul (MRO) and components.

 

In 1HFY2023, total passenger-km rose 47.2% y-o-y, although the number is still 9.7% below its 1HFY2019 levels. 

Notably, the Asia-Pacific region is lagging behind other regions at 20.3%, due to it seeing the resumption of air travel last.

 

With air travel within Asia gaining pace from 2HFY2023, ST Engineering&rsquo s MRO bases in China, Vietnam and Singapore are poised to gain from the higher demand for MRO and components.

 

Meanwhile, Mak is optimistic about ST Engineering&rsquo s urban solution and satcom (USS) sector.

 

&ldquo TransCore&rsquo s acquisition is on track to be earnings accretive from 2HFY2023, we believe, leading to positive FY2023 earnings before interest and taxes (EBIT) for the USS division,&rdquo she writes. 

 

TransCore was acquired in March 2022 for $3.6 billion, at a goodwill of $2.3 billion.

 

Although it booked a net profit of $61.9 million from March to December 2022, this was offset by transaction and integration expenses of $30 million in FY2022 and $8 million in 1HFY2023, along with increased interest costs and goodwill amortisation.

 

Furthermore, TransCore received the notice-to-proceed for the New York Congestion Pricing project in June 2023, which is scheduled for completion by 2QFY2024.

 

The analyst notes: &ldquo We think this project could lead to more opportunities in other US cities. TransCore is on track to be earnings accretive from 2HFY2023 with contribution from this project and the fading of transaction and integration expenses.&rdquo

 

PHILLIP Securities has initiated coverage on ST Engineering : S63 0% with a &ldquo buy&rdquo recommendation and target price of S$4.50, as it expects defence spending to increase amid heightened geopolitical tensions and cybersecurity threats.

 

Singapore had stepped up defence and security spending in FY2021 and FY2022. The research team expects this amount to rise further in FY2023, providing revenue visibility for the mainboard-listed technology and engineering group.

 

The group&rsquo s defence and public security segment won S$5.2 billion in contracts in the first half of 2023, which was 20.9 per cent higher than that for the entire FY2022.

 

The recovery in the aviation sector will also boost demand for the group&rsquo s maintenance, repair and operations (MRO) business, as well as aircraft parts, the research team noted.

 

&ldquo As Asian air travel gains pace from H2 2023, ST Engineering&rsquo s MRO bases in China, Vietnam and Singapore are poised to gain from higher demand for MRO and components,&rdquo said research manager Peggy Mak.

 

Furthermore, Transcore &ndash a US transportation company acquired in 2022 &ndash is on track to be earnings accretive. In June, Transcore received a &ldquo notice to proceed&rdquo for its New York Congestion Pricing project, slated for completion in the second quarter of 2024.

 

&ldquo We think this project could lead to more opportunities in other US cities.&rdquo

 

Mak added that contributions from this project, together with the fading of transaction and integration expenses, could put Transcore on the road to being earnings accretive from H2 2023.

 

In its H1 financial results release, ST Engineering said it expects Transcore to be earnings accretive in 2024, supported by project deliveries weighted in the second half of this year.

 

Analysts have maintained their positive views on Singapore Technologies Engineering&rsquo s (ST Engineering) S63 -0.26% , given improving results across its various key businesses, and how its order book, at a record of $27.7 billion, will give plenty of earnings visibility ahead.

 

On Aug 11, the group announced that earnings for its 1HFY2023 was $280.6 million, up 0.2% y-o-y. Earnings per share (EPS) was up similarly by 0.2% y-o-y to 9.01 cents.

 

Revenue in the same six month ended June was up 13.9% y-o-y to $4.86 billion, with higher contributions across its three business segments.

 

Meanwhile, gross profit saw a significant rise of 15.5% y-o-y to $980.4 million, whilst group ebitda rose 16% y-o-y to $711 million.

 

Following the healthy set of results, Citi Research has upgraded its call to &ldquo neutral&rdquo from &ldquo sell" previously, whilst DBS Group Research, Maybank Securities, UOB Kay Hian, RHB Bank and CGS-CIMB Research have all kept their &ldquo buy&rdquo and " add" calls.

 

Citi, Maybank, UOB, RHB and CGS-CIMB have also raised their target prices, whilst DBS has kept its target price of $4.20 unchanged.

 

Citi has raised its target price to $3.76 from $3.33, Maybank to $4.20 from $4.10 previously, UOB to $4.20 from $4.00 previously, RHB to $4.50 from $4.25 previously, and lastly CGS-CIMB to $4.27 from $4.00 previously.

 

Citi analyst Jame Osman says he is &ldquo encouraged&rdquo by ST Engineering&rsquo s efforts to manage costs incurred from running underperforming assets, capital recycling to reduce its gearing levels while driving operational leverage as well as margin improvement in the core businesses such as the defence and public security (DPS) segment, which is seen to benefit from the momentum of new order wins.

 

Osman is also cheered by the improving commercial aerospace (CA) segment, which is riding on the recovery in air travel. For one, ST Engineering says it is on track to turn ebit positive on its passenger to freighter (PTF) business this year, while its engine/component MRO demand is showing signs of improvement.

 

Osman notes that while there are near-term worries such as labour shortages and supply chain bottlenecks, topline momentum &ldquo appears to finally have driven&rdquo underlying operational leverage.

 

ST Engineering has also continued to invest in significant hangar capacity in the US and China so that it can capture potential growth ahead. However, in doing so, it could result in some front-loading of expenses.

 

As for ST Engineering&rsquo s urban solutions and satcom sector (USS) business segment, the group highlighted that its 20% reduction in headcount of its satcom business portfolio should reduce costs by $30 million to $60 million over the next five years, although it also flagged that continued research and development (R& D) investments will be required to future-proof the business.

 

Ebit levels for the USS are comparable to FY2022, as its performance will be weighted to 2HFY2023 from projects including TransCore and its Kaohsiung rail contracts.

 

The group expects TransCore, which was acquired at a cost of US$2.7 billion in early 2022, to turn earnings accretive in its second year, along with more project deliveries.

 

&ldquo We think ST Engineering&rsquo s stronger topline momentum is finally beginning to drive better operational leverage in its core businesses,&rdquo says Osman.

 

&ldquo However, we remain cautious on the near-term risk factors [which are] cost inflation and inflation,&rdquo opines the analyst, who has raised his EPS estimates by 11%, 10% and 5% for the FY2023 to FY2025 mainly on expectations for ST Engineering&rsquo s margins to grow in a more sustainable manner.

 

Meanwhile, Maybank Securities analyst Kelvin Tan believes that ST Engineering, with earnings seen to grow at a CAGR of 14% between FY2022 to FY2024, &ldquo remains a good investment&rdquo , given its undemanding valuation now.

 

Supportive factors includes the recovery of the CA segment, which is seen to deliver 14% ebit CAGR. Next, contribution from TransCore, plus annual cash savings from streamlining and restructuring in USS, will help lift this segment&rsquo s ebit by a 64% CAGR. In addition, the DPS segment will benefit from rising defence spending in Singapore, says Tan, who expects this division to enjoy 7% CAGR for FY2023 to FY2025.

 

Tan believes upside catalysts might come from higher-than-expected PTF work from airlines upgrading their passenger fleets with supported cargo growth, and better-than-expected margins if aircraft original equipment manufacturers (OEM) slow down their aftermarket expansion due to full order books.

 

Further upside can be expected if ST Engineering wins more orders from US defence and infrastructure projects, an area that ST Engineering has been pursuing but where large contracts have been few.

 

On the other hand, downside risks include the ongoing rise in inflation which could make aircraft materials and equipment more expensive, as well as growing competition from aircraft makers themselves namely Boeing and Airbus in the aftermarket-MRO space.

 

UOB analyst Roy Chen notes that last year&rsquo s 1HFY2022 profit was significantly helped by one-offs, whereas the 1HFY2023 result was driven by core performance.

 

The analyst also points out that ST Engineering&rsquo s guided orderbook of $4.4 billion expected to be delivered in 2HFY2023 is &ldquo slightly lower&rdquo compared with the $4.6 billion guidance &ldquo given a year ago&rdquo for 2HFY22.

 

Chen includes negative margin surprises due to project cost overrun and inflationary cost pressure as key risks.

 

RHB analyst Shekhar Jaiswal is concerned with financing costs to be incurred by ST Engineering. He notes that ST Engineering issued a US$500 million ($677 million) three-year fixed-rate bond in May at a yield of 3.3%.

 

&ldquo It is guiding for a FY2023 borrowing cost of low 3% and a FY2024 borrowing cost of mid-3%. While ST Engineering expects the total borrowings to drop to mid-$5 billion in December from $6.2 billion in June, based on our forecasts, we found it difficult to build it in,&rdquo says Jaiswal, who nonetheless, expects debt to to gradually decline in FY2023 to FY2025.

 

Meanwhile, key drivers cited by the analyst include strong order wins and contributions from acquisitions, whilst key risks include a lower revival in the CA sector, lower than expected contribution from acquisitions and lastly a delay in the implementation of Singapore&rsquo s smart nation initiative.

 

For CGS-CIMB analyst Lim Siew Khee, there was a bright spot in the 1HFY2023 results in the form of $300 million in ebit booked by the DPS segment.

 

She also noted how the USS segment continues to harvest from the acquisition of Transcore, as its 1HFY2023 revenue rose 27% y-o-y to $741 million.

 

&ldquo The execution of the US $500 million ($677 million) New York Congestion Pricing project in 2HFY2023, streamlining of Satcoms, as well as easing of supply chain pressures should result in a significantly stronger 2HFY2023 for the USS segment,&rdquo says Lim.

 

Lastly, DBS analysts Survo Sarkar and Jason Sum like STE for its long-term prospects.

 

&ldquo The big story is that instead of revenue stagnation seen historically, growth momentum will continue even beyond that, built on the solid foundation established over the last few years, driving robust mid-single digit organic growth across segments even out to FY2026,&rdquo the analysts note.

 

Sarkar and Sum include the group&rsquo s exposure to global slowdown as a key downside risk: &ldquo Deeper than expected recession scenario in the developed economies of the west could dent earnings outlook, as STE derives a significant amount of revenue from the US at 23% and Europe at 20%.