S&P downgrades ST Engineering on higher debt levels following TransCore deal

S&P Global Ratings has downgraded the credit rating of Singapore Technologies Engineering (ST Engineering) to "AA+" from "AAA", as the company would be facing elevated debt levels for at least the next 2 to 3 years after the TransCore deal.

The S$3.6 billion acquisition of 2 transport solutions firms in the US, which was first announced in October last year and completed on Mar 18 this year, will almost triple ST Engineering's debt to S$5.3 billion in 2022, from S$2.1 billion as at the end of last year, said S&P analysts Pauline Tang and Minh Hoang in a research report on Wednesday (Mar 23).

"(ST Engineering's) sizeable debt burden will weigh on its balance sheet over the next 1 to 2 years," the credit ratings agency added.

Based on their forecasts, its debt-to-Ebitda (earnings before interest, taxes, depreciation and amortisation) ratio, which measures a company's financial leverage and its ability to pay off its debt, is estimated to increase to 4 in 2022.

The company has become more growth-oriented, with its debt-to-Ebitda increasing steadily over the last few years. It went up to 2 in 2019 from 1 the year before, after it acquired nacelle manufacturing and satellite communications.

While Tang and Hoang said that the engineering and aerospace giant's takeover of TransCore Partners and TLP Holdings does have the potential to contribute to higher earnings, the benefits from possible business synergies will take some time to materialise.

It noted that the 2 companies, collectively known as TransCore, specialise in toll collection systems among several other products predominantly in the US, where S63 does not have a similar presence. The addition of TransCore's portfolio will provide ST Engineering a new product offering in the smart mobility segment, as well as some geographical diversification for the company.

Nonetheless, the company's ability to bid for sizeable overseas contracts is limited in the absence of a comprehensive enough suite of products to be able to provide full in-house manufacturing and engineering, noted Tang and Hoang.

"It will take some time for ST Engineering to build its expertise and recognition to match those of sizeable peers," they added.

The slow recovery in the aviation industry, which had been beaten down in the last 2 years due to the Covid-19 pandemic, would also hinder any meaningful reduction of debt, noted Tang and Hoang.

"We believe earnings growth, rather than proactive debt reduction, is likely to facilitate any deleveraging plan. However, the pace of earnings growth is unlikely to offset debts incurred from the acquisition," they added.

Tang and Hoang estimate that TransCore will likely contribute between S$200 million and S$250 million in ST Engineering's earnings over the next 1 to 2 years, paling in comparison to the S$3.6 billion debt the firm had taken on to fund the acquisition.

Even though ST Engineering reported a record high of orders amounting to S$19.3 billion in 2021, Tang and Hoang expect revenue generation to be gradual and span over several years.

They estimate that the company's annual Ebitda will come in at between S$1.3 billion and S$1.5 billion in 2022 and 2023, including contributions from TransCore. This would mean an annual growth of between 10 and 20 per cent, compared with 2021.

Despite the downgrade, Tang and Hoang's outlook on ST Engineering remains stable, as they expect the company to still generate steady cash flow and maintain its dominant and critical role in Singapore's defence industry.

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