ST Engineering shares hit a 1-year high. More upside from greater defence spending?

What happened?

Singapore Technologies Engineering’s share price recently reached a 52-week high of S$3.98.

Based on its share price of S$3.94 as of 16 October 2023, ST Engineering has risen by close to 18% over the past year. 

This would mean that ST Engineering’s share price has far outperformed the Straits Times Index (STI), which fell by 3% over the same period. 

ST Engineering's share price performance would also be in stark contrast to many other stocks which recently hit a 1-year low, including Venture Corp, Mapletree Pan Asia Commercial Trust, and OUE Commercial REIT.

For investors who may not be familiar with ST Engineering, it is an engineering company with three key business segments – Defence & Public Security, Commercial Aerospace, as well as Urban Solution & Satcom.

 What has captured investor’s attention is the company’s exposure to defence spending. In the first half of 2023, defence revenue of S$1.6 billion represented close to one-third of the company’s group revenue. 

With the renewed spotlight on global defence spending in recent weeks, defence stocks have seen a share price boost.

This led to questions about whether there could there be more upside to ST Engineering’s share price? Let’s find out.

What investors may like about ST Engineering 

#1 – Building up its order book

Over the years, ST Engineering has been bulking up its order book.

The graph above shows the steady upward progression of the group’s order book since 2018.

1H 2023 saw ST Engineering’s order book hit an all-time high of S$27.7 billion after as the company clinched around S$9.5 billion worth of contracts.

It’s important to note that the increase in its order book came about even as ST Engineering exited its US Marine business back in November last year.

The divestment removed S$1.9 billion from its order book but the group still managed to make up for this loss by snagging contracts for its other divisions. 

Commercial aerospace took the lead at S$2.3 billion in the second quarter of 2023.

Defence & Public Security also did well with S$1.9 billion of contracts in the second quarter of 2023. This would include international defence contracts from customers in Europe and the Middle East. 

#2 – Steady increase in revenue and net profit

A quick look at ST Engineering’s financials tells the story of a business that has steadily grown its top line.

From 2018 to 2022, revenue went up by 35% from S$6.7 billion to S$9 billion while net profit increased by 8.3% over the same period.

Cost increases, including integration expenses related to a major acquisition of TransCore (more on this later), were the key cause of the lower increase in profit compared to revenue.

As an example, the first half of 2023 (1H 2023) saw revenue rise nearly 14% year on year to S$4.9 billion.

Net profit appears to have stalled with just a tiny 0.2% year-on-year increase.

However, ST Engineering stated that net profit excluding one-off items climbed 26% year on year to S$300 million.

Hence, ST Engineering has been growing both its top and bottom lines over time in tandem with its order book.

ST Engineering paid out a steady dividend per share of S$0.15 historically, and this was raised to S$0.16 in 2022. 

#3 – Targeting revenue to reach S$11 billion by 2026 

ST Engineering held its last Investor Day back in November 2021 where it laid out an ambitious road map for its 2026 targets.

It targets to grow the group’s revenue by two to three times the annual GDP growth rate to eventually hit more than S$11 billion by 2026 from S$7.2 billion in 2020.

In particular, Commercial Aerospace revenue is targeted to hit more than S$3.5 billion by 2026 while Smart City revenue is targeted to more than double and exceed S$3.5 billion.

Along with the growth in other core businesses and its digital cloud and cyber businesses, ST Engineering is aiming to grow its net profit in tandem with revenue growth.

The Investor Day also identified a total addressable market of more than US$5 billion from 2021 to 2026 for international defence, another area where ST Engineering sees good growth potential.

What investors may not like about ST Engineering 

#1 – Higher debt levels with TransCore acquisition

One area of concern is the group’s burgeoning debt load that was taken up to finance its acquisition of TransCore, a leader in the US transportation industry that provides electronic toll collection services and intelligent transportation systems.

The acquisition, which cost an eye-popping US$2.7 billion, was completed in March last year.

As of 30 June 2023, ST Engineering’s balance sheet held close to S$6.2 billion of debt with just S$387.2 million of cash.  This would translate to a net gearing of 2.1x.

Finance costs for 1H 2023 also more than tripled year-on-year from S$42.1 million to S$127.2 million.

However, ST Engineering’s management expects total borrowings to be reduced to mid-S$5billion in December 2023 from operating cash flow and aviation asset sales to its joint ventures.

In addition, management expects the company’s borrowing cost to remain manageable,  with weighted average cost estimated at low 3% in 2023 and mid 3% in 2024. 

What would Beansprout do?

With one-third of its revenue coming from defence-related spending, ST Engineering is back in the spotlight once again.

We like ST Engineering for its consistent growth in orderbook, which has also translated to an increase in its adjusted profit in 2022.

The company has also paid out a consistent dividend. Based on its 2022 dividend per share of S$0.16, the dividend yield of ST Engineering is at 4.1%.

However, we would be watchful of the company’s debt load as the world is entering an era of high-interest rates that may remain high for an extended period.

The stock is currently trading at a P/E ratio of 21x, above its historical average of 18x. This would suggest investors are already fairly optimistic on the company’s prospects.

According to consensus estimates as of 16 October, the target price of ST Engineering is S$4.15. This would be just about 5% higher than its current share price of S$3.94.

Related links:

• ST Engineering share price and analysis
• ST Engineering dividends

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