STEng – DBS

Aerospace facing headwinds

Story: 1Q08’s net earnings of $122.5m (+13%) were in line, accounting for 22% of our full year forecast. However, EBIT’s growth of 3% was disappointing, net earnings were lifted by investment income, and lower effective tax rate.

Point: Aerospace disappointed, as the effects of a slowdown in US airlines and weak US$ dampened revenue growth (+3%) and EBIT margins (-1% to 14%). PBT would have dipped 5% if not for an investment gain of S$11.5m. Group incurred forex loss of S$4m. The only bright spot was Land Systems, which saw sales rising 22%, driven by a 72% growth in M&W division. Better product mix in M&W led to PBT growth of 34% and PBT margin expansion by 1 ppt in 1Q08. The Marine sector saw a 10% dip in PBT as the frigate contract is near completion and demand for shipbuilding activities reduced in the US. PBT margins declined in the Electronics group as well, from 9.6% in 1Q07 to 8.2% in 1Q08 owing to delay in launch of iDirect’s new product and divestment of ECS. The Electronics segment should rebound in 2H08, though,with the launch of new products in iDirect by end-June.

Relevance: We have revised our FY09 earnings estimates by 5% on the back of lower growth forecasts in the Aerospace sector as the lag effect of US airlines seeking to cut MRO budgets, will be felt from 2H08. Tough operating environment has resulted in the termination of four budget carriers and the merger of Delta and North-West. Margins will be pressured by a weak USD – every 1% drop in the US$ affects PBT by S$1.6m. We have cut our SOTP based target price to S$3.50, and maintain our HOLD recommendation in the absence of any near-term growth catalysts. Stock price should be supported by strong order book of S$9.2b (down from $9.5bn adjusted for the loss of Skybus contract), high ROE of 31.5% and dividend yield of 5.6%.

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