## Tuesday, November 11, 2014

### Valuation of ST Eng based on order book

ST engineering had been dropping like crazy the last few weeks, and very recently in the last few days, the sell down persisted at a much greater pace. I know that they had a weak quarter, and possibly they will end this financial year with similar revenue but weaker net profits. My class got cancelled, so I had some time to crunch some numbers.

Here's a fancy 5 yr key financial data taken from their site:

A few things to take note:

1. The net profit margin (Net profit/Revenue) hovers around 8% in 2009 to 9% in 2012.

2. The number of shares taken to calculate the earnings per share (EPS) increases from around 30 units to around 31 units.

(What units? EPS is net profit over shares, so if you manipulate the formula you'll get shares = net profit/EPS. And that's what I did. I took the net profit for each year divided by the EPS to get the shares, but I can't be bothered to convert to the proper units. Not that it mattered later on when I use it for calculations.)

The 10 yr order book is provided in the annual report 2013 too. Here it is:

Since the share price of a company should be forward looking, knowing the current order book for the next 10 yrs should determine the current price of the shares now. What I wanted to find out whether I can use the order book to guestimate future revenue booked. Since I know the historical net profit margins, I can guestimate the future net profits. If I divide this by the number of shares unit by the company, I'll have the future EPS. Multiply EPS by the historical PE ratio, I'll have the future price range, and I can decide from there what to do with this garbage-in-garbage-out number so expertly calculated.

Let's go.

First, a little back testing. Since they have the 10 yr order book data for 2003 and 2008, I can use it to see if this is even worth the bandwidth posting. Here it goes:

Assumptions:
1. Share units of 31 (more conservative than 30)
2. Net profit margins of 8% (more conservative than 9%)
3. PE range from 10 to 20 (theoretically it should be 10 yrs, isn't it, since it's a 10 yr order book)

10 yr order book for 2003: \$4.6b
Net profit for 2013: \$368 mil (4.6*1000*0.08)
EPS for 2013: 11.9 cts/shares (368/31)

Using PE of 10, share price = \$1.19
Using PE of 15, share price = \$1.78
Using PE of 20, share price = \$2.37

So, based on this order book estimation model, I get around the price range of 1.78 to 2.37. Let's tally it with the historical share price around mid 2002 to mid 2005. You can see that from mid 2002 to end of 2003, the price hovers around a range of 1.6 to about 2. Alright lah.

Let's try for order book for 2008.

10 yr order book for 2008: \$10.6b
Net profit for 2018: \$848 mil (10.6*1000*0.08)
EPS for 2013: 27.3 cts/shares (848/31)

Using PE of 10, share price = \$2.73
Using PE of 15, share price = \$4.10
Using PE of 20, share price = \$5.47

I attach the historical share price from 2007 to 2009 here. Price ranged from about 2 to 4. A little unfair cos it's the global financial crisis, so the PE is depressed by that event. I leave it to you to decide if you can use the order book as a suitable model of valuation based on this 2 samples.

Ah ha, here's what we've been waiting for. Let's try for order book 2013.

10 yr order book for 2013: \$13.2b
Net profit for 2023: \$1056 mil (13.2*1000*0.08)
EPS for 2023: 34.1 cts/shares (1056/31)

Using PE of 10, share price = \$3.41
Using PE of 15, share price = \$5.11
Using PE of 20, share price = \$6.81

A big caveat here here is that this is of course a simplified model. I'm using net margin of 8% on any revenue booked, but it will change when the composition of the revenue is changed. It could be higher or lower. There's also another consideration - the dividend. Let's say the dividend, which is 15 cts now, will drop to 14 cts in the future. Based on 10 times PE, the yield will be a reasonable 4.1%, with the possibility of the share price 'upgrading' to a PE of 15, possibly booking another 50% capital gain.

My second tranche of averaging down will be a little more pessimistic. Here's a chart that I did quite some time ago before all the plunging of the share price recently.

3.3+ to 3.22 will be where my bullet is aiming. I'll see how it reacts around 3.3+ first before deciding further. And how did I react to the falling share price? Nothing. Unlike the past, I didn't put in more than what I can afford to lose, and this is not an s-chip like longcheer or china milk or ferrochina.

What a journey it had been from then and now lol!

B said...

Hi LP

Thanks for the hard work :D

Btw, how did you manage to get the EPS estimate for 2023 at 34 cents. Based on the 2013 actual results, the EPS comes in at 18.73 cents. I'm assuming you are using more conservative figure for net margin, etc so the figure should be lower. Maybe I'm misundertanding something :)

The recent results shows probably that despite the orderbook profits are not going to overtake last year. The management has lowered their dividend payout policy, probably in a stance to undertake more projects in the future.

la papillion said...

Hi B,

Ya, the eps for 2013 is 18.73 cts. But I'm using the order book for 2013 to guesstimate the revenue for 2023. As I said, it's a gueestimate :)

So i use the order book to get the revenue, then multiply by the net margins of 8% to get net profits, divided by shares to get EPS, then multiply by PE to get share price.

I don't get you, you're saying that the EPS for 2023 that I guestimate is too little or too much? I'm guessing it's too much...it'll require a growth of about 7% per year to go from 18.73 to 34 cents in about 10 yrs time.

B said...

Ahh I get your point now.

You are taking a 7% growth profile based on the 2013 orderbook they had. My bad.

I'm assuming the growth of 7% will be really good for a defensive profile like ST Eng. They've probably done it in the past but now that their business are more diversified and conglomerate, 7% is a little steep for me. But that's just me :)

SMK said...

What a quality post!

Thank you for your hard work.

my guess is same as yours. 3.2+

I am using emotional analysis. I have feeling that the rotation out of this will persist til the rate hike. Then from there, who knows.

la papillion said...

Hi B,

Didn't read my post but just scanned through it right? Lol!

To correct u, I didn't assume 7% growth. I literally took the order booking for 2013,and back calculate the EPS using a fixed net margin of 8% (based on last 5 yrs). It threw out a number for me and from that number, I calculated that the growth rate is 7%, which I also think is excessive.

This is all based on 2013 data of course, without including any info from 2014 data. I understand that the net margins had fallen in 2014 (same revenue projected but lower net profit). Not sure if this is an anomaly or sign of things to come.

We shall see :)

My 15HWW said...

Hi LP,

Interesting way of modelling to get an intrinsic value of the share.

Guess I can try this for other shares (i.e. Keppel & Boustead) which depend heavily on order books.

Anyway, I am a little confused here. Shouldn't the first calculation be the price range for 2013, the 2nd for 2018 and the last for 2023?

B said...

Hahaha reading in the office. So need to be discreet and can't read properly.

Thanks for clarifying LP.

la papillion said...

Hi smk,

Wow, 3.2 will be a good price to go in.. Defensive sector with 4+% yield won't go too wrong. It's a price to keep ;)

la papillion said...

Hi 15hhw,

I wanted to do that initially, but I thought otherwise. The share price is forward looking, so the current share price now should reflect all the available info we have now. So imagine, if it suddenly receives an order book of another 1b,the price should go up now right, not wait 10 yrs to go up. That's the theory for the model anyway.

I know how bullshit it sounds lol, but hey, every valuation model also have its own bullshit Haha!

la papillion said...

Hi B,

Haha, no problem :) I understand :)

My 15HWW said...

Hi LP,

I can understand the forward-looking part but somehow if the EPS in 2023 is estimated to be \$0.34, I would be willing to pay \$5.10 (PE=15) to own this share only in 2023. Probably not 2013?

I mean if the order book remains at 13.2B in 2018, the price will be stagnant at \$5.10 for 5 years? So alot of growth is being assumed for us to pay a price of \$5.10 in 2013.

Since you have 3 points for the order book, I was thinking maybe we can take an average?

Order book in 2003 is 4.6B and in 2008 is 10.6B, so average is 7.6B. EPS for 2013 would then be \$0.196. So PE = 15 means price would be \$3 in 2013

Order book in 2008 is 10.6B and in 2013 is 13.2B, so average is 11.9B. So EPS for 2018 would then be \$0.307. So PE = 15 means price would be \$4.50 in 2018.

With this more conservative calculation, as at today's price, there's still an annualised 7% appreciation to be made till 2018. =)

Anyway, this is just a small suggestion and hopefully serves as some food for thought for everyone.

Thanks for sharing your model and valuation once again!

la papillion said...

Hi 15hww,

Hmm, you do make a lot of sense. The order book is not static too, and new orders are constantly added and revenue and earnings constantly incorporated in, so it's right to do an average of the order for the 3 points too. Your approach will also solve a lot of theoretical issues that I had :)

Well done!

Seems like \$4.50 in 2018 is not a bad target ;) With the price closing today at 3.48, are you interested? Or have you already initiated a position? Hhaah :)

Sillyinvestor said...

Hi LP,

I dun quite understand your model.

Why did u extrapolate 2013 orderbook into 10 years?

Assume order book stay the same for the next 10 years?

Order book will most probably run out in 2-2.5 years if no new order intake.

Personally,
I think market is over- reacting ...

Without impairment of Europe operations, profits fall will be small. Since impairment is for closure of facilities and not due to delays, we can be quite assure the impairment is unlikely to be recurring since Europe is not a big contribution to top line anyway.

It could also be market is factoring growth and is Ailey disappointed.

I think dividends will fall too.

la papillion said...

Hi SI,

I might have made a fatal mistake. I have thought that the 10 yr order book is the orders that is going to be booked in the future 10 yrs (I've no idea why I got that idea). Your question jolted me to the fact that it might be the order for the past 10 yrs from 2003 to 2013!

Still, this might still be salvageable. It might take that long for all the revenues from the order book to come in. Hmm, but i think it should be shorter than 10 yrs. What do you think?

I've no idea why the price fell so much. I guess it's not our job to find out why. We just need to know what we will do when it reaches the price point we want.

Createwealth8888 said...

How about doing one for Kep Corp's Order Book?

Sillyinvestor said...

LP, I think the order book should run out in 2 plus years. Given revenue is 6 billion. Management expect to deliver 1.6 billion in q4, so correct, in a year about 6 billion to be delivered.

Hence, I think maximum 3 years order book will be gone.

Actually too big a order book also no good. 3 years is the best, because anything beyond that, costs calculations might go hey wire

More important to replenish the order book

la papillion said...

Hi bro8888,

Haha, no skin in the game..if I've skin , I'll do it ;)

la papillion said...

Hi SI,

Thanks for your feedback :) Yes, you're right, 13b order book, if one year 6 billion, 2 to 3 yrs order book if not replenished will be gone.

This exercise made me focus a little harder on their margins. It's the key to converting revenue to earnings stream. Going forward, might not be going to be so high. Will adversely affect ROE too. Hopefully they won't take up more debts to boost their ROE.

I'm still interested to get in another batch at around 3.2+ though.

Derek said...

Hi LP,

I'm actually glad that the price is dropping because I started DCA two years ago and the price keep creeping up. Now I can finally get more units.

Cheers!

la papillion said...

Hi Derek,

Didn't know u did a dca on this. Lower prices then! ;)

Derek said...

Hi LP,

It comes with my job. Shh...don't tell anyone ya.

Cheers!
Derek

David said...

I'm looking to pull the trigger on st engg too at \$3.33 or lower. Thanks for your in-depth analysis.

SMK said...

Oil rout encourages lower tide.

Finally 3.2 is within sight.

la papillion said...

Hi,

I'm watching it closely now ;)