Singapore Technologies Engineering: Decent First Half 2020 Performance Aided By Government Support (OTCMKTS:SGGKF)

Elevator Pitch

I maintain a Neutral rating on Singapore-listed Singapore Technologies Engineering (OTCPK:SGGKF) (OTCPK:SGGKY) [STE:SP], a conglomerate with diversified business operations in aerospace, electronics, land systems, and marine.

This is an update of my prior article on Singapore Technologies Engineering published on March 5, 2020. Singapore Technologies Engineering’s share price has decreased by -22% from S$4.36 as of March 4, 2020 to S$3.41 as of September 10, 2020, since my last update. Singapore Technologies Engineering trades at 19.8 times consensus forward FY 2021 P/E, and it offers a consensus forward FY 2021 dividend yield of 4.3%.

Singapore Technologies Engineering’s net profit attributable to shareholders only declined by -4% YoY in 1H 2020, thanks to government support which is expected to exceed S$300 million for full-year 2020. But Singapore Technologies Engineering is expected to deliver a weaker financial performance in 2H 2020. Also, the weakness in the aerospace business and the reduction in government support are key concerns.

I see Singapore Technologies Engineering as fairly valued considering the potential headwinds for the company in the near term, and I retain my Neutral rating on the stock.

Readers have the option of trading in Singapore Technologies Engineering shares listed either on the Over-The-Counter Bulletin Board/OTCBB as ADRs with the tickers SGGKF and SGGKY, or on the Singapore Stock Exchange with the ticker STE:SP. For those shares listed as ADRs on the OTCBB, note that liquidity is low, and bid/ask spreads are wide.

For those shares listed in Singapore, there are limited risks associated with buying or selling the shares in terms of trade execution, given that the Singapore Stock Exchange is one of the major stock exchanges that is internationally recognized, and there is sufficient trading liquidity. Average daily trading value for the past three months exceeds $12 million, and market capitalization is above $7.7 billion, which is comparable to the majority of stocks traded on the US stock exchanges. Institutional investors who own Singapore Technologies Engineering shares listed in Singapore include Capital Research Global Investors, BlackRock, The Vanguard Group, Norges Bank Investment Management, and MFS Investment Management, among others. Investors can invest in key Asian stock markets either using U.S. brokers with international coverage such as Interactive Brokers or Fidelity, or international brokers with Asian coverage like Hong Kong’s Monex Boom Securities and Singapore’s OCBC Securities.

Government Support Boosted 1H 2020 Results

Singapore Technologies Engineering announced the company’s 1H 2020 financial results on August 14, 2020, and the company’s financial performance was decent despite COVID-19 headwinds.

Singapore Technologies Engineering’s revenue increased by +2% YoY from S$3,511 million in 1H 2019 to S$3,572 million in 1H 2020, while its net profit attributable to shareholders declined by -4% YoY from S$269.3 million to S$257.4 million over the same period. The company’s bottom line benefited from various government support schemes and initiatives (to help businesses tide through the COVID-19 crisis) in the different markets and countries that it operates in. Singapore Technologies Engineering disclosed in the company’s 1H 2020 results announcement that it “expects to receive more than S$300 million in government support for full year 2020”, of which less than half has been received and recognized in 1H 2020.

The company’s headline +2% top line growth was better than what it seems on paper. Singapore Technologies Engineering’s adjusted organic revenue would have declined -7% YoY, if revenue contribution from the recently acquired MRA Systems, LLC or MRAS (an Original Equipment Manufacturer or OEM of engine nacelle systems in the aerospace segment) and Newtec Group NV (satellite communications company in the electronics segment) were excluded.

In terms of performance by business segment, Singapore Technologies Engineering’s aerospace segment saw a -24% YoY drop in segment profit before tax from S$158.5 million in 1H 2019 to S$120.3 million in 1H 2020. I will be discussing more about the aerospace business in a subsequent section of this article in greater detail.

The company’s marine business segment did not perform as well, as its segment profit before tax fell -30% YoY from S$31.5 million in 1H 2019 to S$22.1 million in 1H 2020. This was largely attributable to the weak performance of the marine business’ shipbuilding division in the US. Singapore Technologies Engineering’s other two business segments fared slightly better. Singapore Technologies Engineering’s electronics business saw segment profit before tax decline marginally by -2% to S$96.6 million in 1H 2020. Its land systems business’ segment profit before tax rose +17% YoY to S$49.2 million over the same period as strength in the defense sub-segment offset weakness in the commercial specialty vehicles sub-segment.

A Weaker 2H 2020 Expected

Sell-side analysts see Singapore Technologies Engineering’s top line and bottom line decreasing by -9% YoY and -12% YoY to S$7,174 million and S$517 million, respectively in FY 2020. This is aligned with management guidance of a revenue decline in the 5%-15% range for full-year FY 2020. Considering that Singapore Technologies Engineering’s net profit attributable to shareholders only declined by -4% in 1H 2020, a weaker 2H 2020 for the company is expected.

Notably, Singapore Technologies Engineering disclosed at the company’s recent 1H 2020 results briefing that the “second quarter saw a harder revenue impact than first” and “the 2% increase in revenue (for 1H 2020 as a whole) we did get some support from our first quarter results.” This supports the case that the revenue decline for the company will be more severe in 2H 2020 vis-a-vis 1H 2020.

On the positive side of things, Singapore Technologies Engineering’s order book will provide downside revenue support, and the company will benefit from Singapore’s extension of the Jobs Support Scheme, a wage support scheme to help companies retain local workers.

Singapore Technologies Engineering has an order book of S$15.9 billion as of June 30, 2020, of which the company expects S$3.2 billion to be recognized as revenue in 2H 2020. Market consensus expects Singapore Technologies Engineering to achieve S$3.6 billion of revenue in 2H 2020, and the company’s revenue supported by its order book accounts of a majority of that.

Also, the Jobs Support Scheme, which was supposed to end in August 2020, has been extended to March 2021 by the Singapore authorities. Sell-side analysts estimate that the extension of the Jobs Support Scheme to March 2021 could potentially add another S$110 million to the current S$300 million in government support that the company has guided that it expects to receive.

Aerospace Business Segment In The Spotlight

As highlighted above, profit before tax for Singapore Technologies Engineering’s aerospace business segment fell -24% YoY to S$120.3 million, despite increased earnings contribution from the newly-acquired engine nacelle systems OEM, MRAS, and government support in the form of subsidies or grants. Notably, the aerospace business accounted for 42% of Singapore Technologies Engineering’s profit before tax in 1H 2020, making it the largest profit contributor for the company.

At its 1H 2020 earnings call on August 14, 2020, Singapore Technologies Engineering disclosed that the aerospace business is at “above two-thirds utilization today” on average (as opposed to operating at close to 100% capacity pre-COVID-19), and the company expects that it “will take at least a couple of years, if not three years or four, to get back to pre-COVID-19 level performance.”

On the flip side, Singapore Technologies Engineering’s MRO (Maintenance, Repair and Overhaul) services for cargo aircraft and its passenger-to-freighter or PTF conversion programs are likely to be bright spots for the aerospace business, and could help to mitigate the overall revenue decline for the segment. With international travel restrictions put in place due to COVID-19, airlines have been shifting their focus from passenger flights to cargo, which resulted in an increase in demand for cargo aircraft. Also, Singapore Technologies Engineering has seen increased interest in its PTF conversion programs for the A330 and A321 platforms recently.

All Eyes On Cost Reduction Initiatives

The majority of government support is likely to go away by 2021, notwithstanding the fact that the Jobs Support Scheme in Singapore has been extended to March 2020 as mentioned above. This implies that Singapore Technologies Engineering has to implement cost reduction initiatives to make up for the eventual loss of government support in 2021 and beyond.

Singapore Technologies Engineering highlighted at its 1H 2020 results briefing that it has already identified areas of cost reduction which are “in the hundreds of millions” and these cost reductions should be realized in the coming quarters and 2021. Cost reduction initiatives already in place include salary cuts for senior management, cutting back on contract workers, and a reduction in travel expenses (as a result of travel restrictions due to COVID-19).

If Singapore Technologies Engineering fails to reduce costs to offset the expected decline in government support going forward, there could be significant downside risks to the company’s earnings in 2021 and beyond.

Valuation And Dividends

Singapore Technologies Engineering trades at consensus forward FY 2020 and FY 2021 P/E multiples of 19.7 times and 19.8 times, respectively based on its share price of S$3.41 as of September 10, 2020. As a comparison, the stock’s five-year and 10-year mean consensus forward P/E multiples were 19.6 times and 19.0 times, respectively.

Singapore Technologies Engineering offers consensus forward FY 2020 and FY 2021 dividend yields of 4.1% and 4.3%, respectively. The company maintained its interim 1H 2020 dividend at S$0.05 per share, which is the same as what was paid out for 1H 2019. Market consensus expects Singapore Technologies Engineering’s full-year dividends per share to decline from S$0.150 in FY 2019 to S$0.139 in FY 2020, before increasing to S$0.147 in FY 2021.

Nevertheless, it is likely that Singapore Technologies Engineering can maintain its full-year FY 2020 dividends at S$0.150 per share (same as FY 2018 and FY 2019). At the company’s 1H 2020 earnings call on August 14, 2020, Singapore Technologies Engineering emphasized that “the dividends that will be payable this year can be adequately funded out of all past years’ retained earnings.” The company has retained earnings amounting to $1,390 million or S$0.445 per share as of end-FY 2019, which is more than sufficient to fund its full-year dividends of S$0.150 per share.

Risk Factors

The key risk factors for Singapore Technologies Engineering include further weakness in the aerospace business segment, a failure to reduce costs to offset the expected decline in government support going forward, and an unexpected cut in dividends.

Note that readers who choose to trade in Singapore Technologies Engineering shares listed as ADRs on the OTCBB (rather than shares listed in Singapore) could potentially suffer from lower liquidity and wider bid/ask spreads.

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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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