Transport Related - 2017 Sector Outlook ~ Focus on Defense
- In a low growth environment, we favour names that have a defensive or resilient business model, and have a strong balance sheet to withstand uncertainty or fund potential inorganic growth.
- While the sector is trading above the STI at an 17.4x FY17F PE with modest EPS growth, stocks in this space are mostly in a net cash position and offer an attractive dividend yield of over 4.5%.
- Our top picks are ST Engineering (BUY, TP S$3.50) ComfortDelgro (BUY, S$3.09) and China Aviation Oil (BUY, TP S$1.70).
Real organic growth will be hard to come by
- Demand environment remains soft amidst tepid global economic outlook. While the World Bank expects global GDP growth to pick up slightly from 2.4% growth in 2016 to 2.8% in 2017, we see the overall demand continuing to be soft in the sub-3% environment.
- Furthermore, savings from lower fuel costs are also being passed on to consumers in the form of lower fares (ComfortDelgro) and ticket prices (SIA), and all these mean that top line growth should continue to be fairly muted.
Strong balance sheets allow for acquisition-driven growth potential.
- An avenue for growth could come from acquisitions as balance sheets are strong across the sector.
- Companies with net cash position include SIA, SIA Engineering, China Aviation Oil and ComfortDelgro while ST Engineering and HPH Trust have relatively low net gearing of 0.1x and 0.4x respectively. We believe that many of these companies are on an active lookout for inorganic opportunities to boost their medium and long term earnings growth.
Attractive yields offset tepid earnings outlook
- Yield of over 4% on offer across the sector. All of the six companies featured in our sector offer a prospective dividend yield of at least 3% (China Aviation Oil), to as much as 8.7% for HPH Trust.
- Meanwhile, two of our top picks ST Engineering and ComfortDelgro are offering an attractive prospective dividend yield of 4.6% and 4.5% respectively.
FY17 earnings growth projected to be at modest mid-single digit pace.
- On a simple average basis, the sector is projected to post a modest 5.4% y-o-y growth in EPS (7.1% on a market cap weighted basis) in 2017.
- Notably, this follows a 5.4% decline in 2016. On simple average, the sector is trading at 18.4x FY16 PE, declining to 17.4x FY17 PE.
Could there be more privatisations/offers?
- Could HPH Trust be an M&A candidate? A number of companies in the transport sector, including NOL, SMRT, Tigerair and China Merchants Pacific, were privatised or acquired in 2016.
- HPHT’s share price is trading near historic lows, offering a prospective yield of 8.7% in 2017F and at 0.6x FY16 P/B, could be attractive as an acquisition target given its strategic assets. Notably, major shareholders CK Hutchison and Temasek themselves are no strangers to privatisations.
Oil prices remain low but a spike would affect operators.
- Crude oil prices have moved off the bottom since the beginning of 2016, and have traded between US$45 to US$55 per barrel in the last 6 months, at an average of US$47.
- While our house view projects that Brent will average around US$50-US$55 per barrel in 2017, representing a modest increase, any unexpected and sustained spike in oil prices would impact operators such as airlines and could also hurt demand.
Growing threat of protectionism.
- Recent major election results, not least the vote for ‘Brexit’ and the US elections, suggest growing support for protectionism and the anti-globalisation movement.
- Increased protectionism globally would be negative for global trade and travel, and perhaps even impact cross-border acquisitions.
Valuations & Stock Picks
- We offer three picks for 2017:
ST Engineering (BUY, TP: S$3.50).
- STE is a relatively defensive stock with a healthy balance sheet and secure dividend payouts, and the recent share price retreat creates a better entry point for the stock.
- Its Aerospace segment has positioned itself well by investing in growth markets such as narrow-body aircraft Passenger-to-Freighter (PTF) conversions, the Chinese MRO market, and cabin interior solutions, to name a few.
- The Electronics segment should also benefit from the ‘Smart City’ trend, not only in Singapore but various overseas markets as well.
ComfortDelgro (BUY, TP: S$3.09).
- We like the Group’s fundamentals and its business and geographical diversification. At current price, it is trading at 16.6x/ 15.3x FY16F/17F PE, which is below its 5-year historical average. Despite the weak global outlook, we expect CD’s DPS to grow with its lower capex requirements.
- In addition, its strong balance sheet avails it the capacity to undertake acquisitions to supplement growth.
China Aviation Oil (BUY, TP S$1.70).
- With the backing of its SOE parent, CNAF, and monopoly in the supply of bonded jet fuel in China, we like CAO as a proxy to the long-term growth of China's international air travel market, growing international presence, and for its exposure to Pudong International Airport's firm outlook through 33%-owned associate, SPIA.
- Currently trading at < 10x FY17F PE, we believe that the group is poised to see a structural re-rating to 12x on sustained earnings growth, especially if CAO can utilise its strong net cash balance of US$203m to further accelerate growth via M&A.