Aerospace growth weakens, Defense surges

Top line and bottom line growth masks weak growth at Aerospace– 1Q08 revenue increased by 7.8%yoy, while PBT rose by 6.2%yoy due mainly to a surge in profits from Land Systems(+34.3%) and higher investment income(+72.2%). Net profit rose by a higher 12.6% due to lower tax provisioning. On a QOQ basis, PBT fell by 11.9% due to lower margins on Aerospace and Marine division. The former was affected by a weak US dollar and translation losses accounted for roughly $4.3m. We are concerned with the slower growth at the Aerospace division, which accounts for the bulk of Group pre-tax profits. Aircraft maintenance and engine overhaul subdivisions which are the largest business units showed pre-tax declines underscoring our concerns that troubles in the airline sector would impact the Aerospace division. It remains to be seen whether the other divisions will pick up the slack. Thus far, Land Systems has done so. For now, we maintain our Hold Recommendation but lower our price target to $3.30 or 19x forward earnings to reflect the uncertainty at Aerospace division.

Growth from Defense related Land systems.- Revenue for the division grew by 21.3% while PBT rose by 34.3%. PBT growth for the division was due to a 170% increase in munitions & weapons pre-tax profit to $24.2m. Excluding this surge, Group PBT would have actually declined. The Electronics division- The division showed a modest 2.1% decline to lower operating profits form satellite communication equipment sales as well as lower associate contribution. Marine division – The division declined in line with guidance as higher margin defense related works ceased.

Slower top line and bottom line growth from Aerospace– The division which still accounts for 53% of group PBT grew by just 2.8% yoy against our full year expectation for 8.7% yoy growth. Revenue from Aircraft Maintanenance & modification(AMM) fell 2.7%, while PBT fell by 6.1%. Revenue from Component Engine repair & Overhaul (CERO) rose 0.8% while PBT fell by 29.4%, underscoring our expectation of higher margin pressure for the Aerospace division for the year.

Outlook-The electronics division should show higher sales recognition form LTA’s circle line project, while Aerospace division should see the delivery of the 1st Boeing 757 Passenger to Freighter conversion in 2Q08. Management has guided improved 1H08 earnings for Aerospace and Land Systems.

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