• Crisis valuations, negatives priced in. STE’s share price has receded 30% YTD on concerns over a slowdown in the global economy and aviation industry. We believe its current crisis valuations (13x CY09 P/E, below its post-911 valuation of 14x in 2001 and close to its post-SARS valuation of about 13x) have incorporated a weak macro outlook and cost pressures on the aviation industry.
• Breather from declining oil prices. The recent retreat in oil prices below US$100/barrel has started to take some pressure off airlines. IATA has also revised its financial forecast for 2008 to a net loss of US$5.2bn, based on an average oil price of US$113/barrel, short of the US$6.1bn worst-case forecast in June when oil cost US$135/ barrel. Although the weakness should persist into 2009, with forecast net losses of US$4.1bn, the outlook is more sanguine than after 911 (US$11bn loss) and SARS (US$6bn loss).
• Defensive. STE’s earnings growth is expected to be decent at a 3-year EPS CAGR of 9% and ROEs towering above 30%. A strong net cash position should also ensure high payouts (100% typically unless there is a large acquisition) with yields of 7%.
• Upgrade from Neutral to Outperform but target price remains S$3.39, still based on blended valuations (DCF, P/E, dividend yield and DDM). We have left our earnings estimates intact. STE is trading at trough valuations of 13x CY09 EPS or a 30% discount to our target price. Key catalysts could include new acquisitions, sizeable contract wins and a strengthening of the US$.