When Singapore Technologies Engineering (ST Engineering) spent US$2.7 billion ($3.7 billion) to acquire US transport management system company Transcore, it was the largest-ever acquisition for a company that up till a few years ago, was better known for steady organic growth.
The deal, first announced last October, was completed in March. It was meant to give ST Engineering a leg up in its overall smart mobility, which is in turn part of a broader, growing market in smart-city systems.
Given how ST Engineering took on significant debt to fund the acquisition, the progress of the deal was naturally a focus when the company announced its 1HFY2022 earnings on Aug 12.
TransCore’s numbers are included within ST Engineering’s urban solutions & satcom (USS) segment, which recorded a revenue of $757 million for the six months ended June, up 43% y-o-y.
However, this segment recorded a loss of $12.1 million, versus an ebit of $11.2 million in 1HFY2021. The red ink can be largely attributed to $21 million incurred in TransCore’s transaction and integration costs.
According to the company, this segment’s numbers were also hit by a weaker performance in its satellite communications (satcom) sub-segment, which continued to be impacted by semiconductor chip shortages.
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Cedric Foo, the company’s CFO, points out that the earnings for this segment have to be seen in the context of a high 1HFY2021 that was “outside of the norm”. The satcom business, according to Foo, is traditionally stronger in the second half of the year. “We believe that will return,” he says.
Vincent Chong, the company’s group president and CEO, acknowledges the supply-chain challenges, adding that ST Engineering is taking various measures to address them, including “sourcing strategy, price adjustment and product redesign to mitigate the full impact”. However, he says: “We are certainly not immune, like many companies around the world.”
He reiterates ST Engineering’s projection when acquiring TransCore that this significant addition to the company will be cashflow-positive from the first year and earnings-accretive from the second year following the acquisition. The transaction costs, he says, are already at the “tail end”.
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The company’s focus on TransCore, says Chong, is to try and win more new contracts. For example, it won orders worth more than $170 million for system upgrades and sale of RFID (radio frequency identification) tags in Florida, West Virginia and Dubai.
Higher financial costs
Now, the costs incurred from the TransCore deal have given rise to some caution on the part of some of the analysts covering this stock. Citibank’s Jamie Osman believes that persistent supply-chain and component shortages pose risks to the recovery of the USS segment, including TransCore. He also sees integration risks, including elevated gearing levels amid the rising interest-rate environment.
Osman, the only analyst with a “sell” call out of a total of 14 analysts with an active coverage of this stock, notes that ST Engineering’s gearing levels have risen higher than what he initially expected, with net debt to equity reaching 2.4x as of end-1HFY2022 versus just 0.5x as of end-FY2021.
He also notes that the company’s first-year financing costs have risen to 2.2%, and that it is currently exploring refinancing options for its US$1.7 billion US commercial paper, which would impact interest costs from FY2023.
RHB Group Research’s Shekar Jasiwal, who trimmed his target price to $4.60 from $4.80, believes that the slew of acquisitions over the past few years, including TransCore, has increased operating costs and the debt burden for ST Engineering.
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“TransCore is expected to keep operating costs elevated, bearing an annual integration cost of $10 million, as well as a debt burden of an additional $700 million of borrowings,” Jasiwal points out. According to Chong, the annual integration costs for TransCore will be from $10 million to $20 million, although he adds that it should come in “closer to the mid-point of that range”. Nonetheless, Jasiwal believes TransCore will also support ST Engineering’s medium-term profit growth in the USS business.
Maybank Securities’ Kelvin Tan, who has trimmed his target price from $4.75 to $4.50, also expects near-term cost pressures to be a drag on the company’s balance sheet. The lower target price is because Tan has trimmed his FY2022-FY2024 earnings forecast by 5%-6% to factor in TransCore acquisition expenses and rising cost pressures.
He also cautions that short-term margins could continue to be hurt by rising operating expenses and front-loaded acquisition expenses, coupled with lingering uncertainty over the global chip shortage.
However, Tan does expect “sequential earnings recovery” in the USS segment in 2HFY2022 as the bulk of transaction expenses were booked in 1HFY2022. “We expect 2HFY2022 to be better with greater contribution from TransCore and gradual aviation recovery,” he adds.
Tan remains optimistic about ST Engineering’s growth prospects given a continual recovery in its aerospace segment, a strong contribution from the TransCore acquisition, and a robust order book, which provides healthy revenue visibility for the next few years.
Other analysts, like Survo Sarkar and Jason Sum of DBS Group Research, have retained their target price of $4.70 in addition to their “buy” call, saying that ST Engineering’s growth trajectory is becoming “exciting”.
They expect the company to report a CAGR of close to 10% in net profit over FY2021-FY2023, driven by contributions from TransCore, plus recovery in the commercial aerospace segment, which has been affected during the pandemic.
ST Engineering as a whole reported revenue of $4.27 billion, up 17% y-o-y, with higher sales recorded across its various business segments. However, earnings were down 5% y-o-y to $280 million.
There were a couple of one-off factors that affected the bottom line. First, the company lost government wage subsidies to cope with the pandemic to the tune of $125 million, which it had for 1HFY2021. There were also the transaction and integration costs from TransCore. If these items were excluded, the company’s earnings would have been $307 million, up 4% y-o-y.
ST Engineering plans to pay a second interim dividend of four cents for 2QFY2022. This is in line with its new dividend policy of having four quarterly payouts of four cents each, instead of an interim and a final dividend for its 1H and 2H. This new payout is a sign of the company’s confidence in the stability of its cash flow.
Strong order book
The 1HFY2022 numbers aside, ST Engineering has much work to do moving forward. In 2QFY2022 alone, it secured contracts worth $3.1 billion, comprising $1.2 billion from the commercial aerospace segment, $447 million from USS, and $1.4 billion from the defence & public security segment, bringing the total contract value secured for 1HFY2022 to $5.5 billion. In total, the company has built up a “robust” total order book of $22.2 billion, up 4% from 1QFY2022.
Some notable contracts that the company has recently secured include passenger-to-freighter conversion orders for Airbus 330 and Airbus 321 planes, as well as an agreement to provide additional airframe heavy maintenance support for United Airlines’ narrowbody aircraft, and several component maintenance-by-the-hour extension contracts from regional airlines.
New wins from the urban solutions segments include rail electronics contracts for metro lines in Singapore, Taiwan and the Middle East, as well as smart utilities and smart security contracts in Brazil and New Zealand.
As for the satcom sub-segment, contracts won include a network expansion contract with satellite operator Measat to enhance connectivity services across Malaysia, as well as a contract with a leading satellite operator to boost capacity on its new GEO HTS satellite.
For its largest revenue contributor, the defence & public security segment, it secured contracts including the development of the largest Southeast Asian hybrid multi-cloud using cloud infrastructure from American cloud company Nutanix, as well as the sales of WiZ-Knight, an ultra-small IP encryptor developed in-house by Digital Systems.
The segment also secured several contracts for ship repair in Singapore and new orders for munitions from international customers and commercial speciality vehicles in the US.
When asked during the briefing which of its three segments ST Engineering would focus on so as to drive growth, Chong simply replies, “All three.” He adds: “This is a very comprehensive suite of strategies that leaves no stones unturned. There’s no focus on just one sector and not the other, so [for] all three segments, we’ll be pushing very hard.”
As of Aug 17, shares of ST Engineering closed at $3.95, representing a year-to-date gain of 5.05% and valuing the company at $12.33 billion.
