Moody's affirms ST Engineering's Aaa issuer rating; downgrades baseline credit assessment to a3

MOODY'S Investors Service has downgraded ST Engineering's baseline credit assessment (BCA) to a3 from a2 based on an expected deterioration of the company's financials following its acquisition of Belgium-based satellite company Newtec Group.

At the same time, the credit rating agency has affirmed the company's triple A issuer rating, which takes into account the a3 baseline credit assessment rating and expectation of "very strong" support from the Singapore government through its wholly owned investment company, Temasek Holdings. The expectation was based on ST Engineering's importance to Singapore as "a strategic contractor and supplier of defence equipment, as well as an employer of highly skilled labour".

Moody's lead analyst for ST Engineering, Nidhi Dhruv, said that although the acquisition of Newtec was relatively small at S$383 million, it "comes close on the heels of STE's (ST Engineering) last debt funded acquisition of MRA Systems for S$868 million, and signals a shift in the company's acquisition strategy and a willingness to lever up its balance sheet".

She noted that its mainly debt-funded acquisitions are significantly larger than the company's recent history of acquisitions, and exposed the company to execution and integration risks. ST Engineering's gross leverage will increase to about 2.3-2.4 in FY2019 and stay above 2.0 in FY2020, which Moody's said are not in line with the company's earlier BCA of a2.

Combining the company's historical record of high dividends and its recent debt-funded acquisitions, Moody's expects weakened cash flow metrics from 42 per cent for 2018 to 17-22 per cent for 2019-2020.

It expects the company to continue seeking acquisition opportunities to grow its top line, upgrade its technological expertise and acquire patents, aligning with the company's five-year plan to strengthen core segments and pursue new growth areas, particularly its Smart City business.

Moody's said that ST Engineering's Aaa rating remains supported by the company's strong technological capabilities, which drive its commercial business, while its defence contracts continue to support its underlying operations. It added that the company has a strong order book, with an order backlog of S$13.2 billion as at Dec 31, 2018, which supports around two times of revenue for 2018.

It added that the company's diversified portfolio of aerospace, electronics, land systems and marine will help mitigate demand volatility in any individual segment.

As at 9.26am on Tuesday, ST Engineering shares were up two Singapore cents at S$3.79.