STEng – DBS

Headwinds just gotten stronger

Story: Several major US airlines, including Delta, Northwest, United Airlines and Continental have recently announced that they would pare domestic seating by 10-18% by the end of the year to counter rising costs and cut unproductive routes. In the process, hundreds of planes would be grounded. According to the main industry trade association’s forecast, the US aviation industry may stand to lose over US$10bn this year, due to the skyrocketing costs of jet fuel.

Point: Third-party MRO operator, ST Aerospace may face the first line of cutbacks in workflow as major airlines seek to cut costs. In our earlier report, we had pointed out that we expect further headwinds in the aerospace segment from U.S. operations, which contributes about 12% of ST Engineering’s (STE) revenue and 15% of its PBT.

Relevance: Downturn in the airline industry usually has a lagged effect on MRO operators, as previous contracts tend to hold up earnings till about 6-9 months after a downturn. Thus, we take a fresh look at our estimates on FY09 earnings, keeping in perspective of the flat growth witnessed in FY02 post-9/11 downturn, and revised down our forecast on FY09 PBT for the aerospace segment by 8% on the back of lower growth and PBT margin assumptions. We have also tuned down our projection on FY09 earnings multiple for the Group to 15x,the lower end of its historical PE band during the SARS period, and arrived at a target price of S$2.80. Though dividend yield of 6% at current prices should provide some downside support, we downgrade the counter to FULLY VALUED.

Switch to SIA Engineering, which promises higher earnings visibility and stable growth, as 70% of its revenue is from the parent, the stock trading at more attractive valuation of 13.5x(FYMar 2010) and dividend yield of 5.3%

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