STEng – DBS

Learning costs proving costly

Story: Though net profit of S$129m (up 2.7% y-o-y) was in line with our expectations, PBT (-6% y-o-y) was below. Net profit was buoyed by a one-time deferred tax credit of S$16.8m. A dip in investment income, higher depreciation costs and prototyping losses from Passenger-to-Freighter (“PTF”) conversions (loss of S$15m in 9M08) in the aerospace segment led to the underperformance.

Point: Aerospace margins continued to slide (-4.4 ppts to 14.5%) and apart from the PTF learning cycle losses, the recent bankruptcy of European customer Sterling Airlines is likely to affect PBT further by at least S$10m over the next 2 years. Revenue from the Marine segment was also down 20% owing to lower shipbuilding revenue. However, both the Electronics and Land Systems segments delivered strong y-o-y revenue growth (+25%), lifting overall 3Q08 revenue by 12%. Profit from Land Systems was impacted, though, by slow auto sales in the US and impairment of a long-term investment. Carrying value of investments at Group level were marked down about 50% to S$22m from S$41m at end-FY07.

Relevance: The outlook for the MRO sector, especially in the US, remains gloomy in the wake of an aviation slowdown and shipbuilding/ shiprepair revenue growth is also likely to be stymied in FY09. We expect the other segments to register decent growth on the back of government spending in transport projects, infrastructure and defence. Overall, we cut FY08 earnings by 3% and FY09 earnings by 5%, as management further lowered guidance to “lower PBT in FY08” vs. “flat PBT growth” previously. Given its defensive reputation, the stock has held up well amidst the recent market turmoil and upside is limited at our unchanged target price of S$2.80.

Maintain HOLD. A robust orderbook of S$9.5b and 7% FY09 dividend yield backed by S$1b cash equivalents, limits downside risks.

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