STEng – CIMB

Weak quarter, lacks near-term catalysts

• Below expectations. 4Q08 net profit of S$85m (-42% yoy) is 33% below our estimate and 31% below consensus. The weakness was due to impairment in the value of long-term quoted investments in Electronics and Land System amounting to S$23m and higher-than-expected provisions for doubtful debts of S$22m. 4Q08 net profit also included a tax write-back of current and deferred tax of S$18m. Stripping out the tax reversal, 4Q08 net profit would have been S$67m or 47% below our estimate, while FY08 net profit would have been S$434m or 15% below.

• Expect continued weak margins for Aerospace. 4Q08 PBT of S$43m (-51% yoy) for Aerospace was 45% below our expectation mainly due to lower-than-expected contributions from associates on lower volume and higher-than-expected provisions for doubtful debts. FY08 PBT margin was only 14% (FY07: 19%). We believe the weakness could persist into FY09 on lower MRO volume due to a challenging aviation industry, higher depreciation expense and losses from PTF conversion projects in 1H09.

• Outlook for FY09. Management expects group turnover to be higher in FY09 and comparable PBT. While Aerospace PBT is expected to be stable, the remaining divisions are expected to perform better. Management is hopeful about defence exports citing high enquiries. Order book was a record S$10.6bn (FY07: S$9.5bn) with about S$3.6bn for recognition in FY09.

• Earnings estimates cut by 9-11% for FY09-10, to reflect guidance. We lower our utilisation rate and margin assumptions for Aerospace and sales growth expectations for Land and Marine. We also introduce FY11 estimates.

• Lack near-term catalysts. STE remains in excellent health with net cash of about S$200m. It has also maintained its 100% dividend payout with a total of 15.8cts declared for FY08. While management continues to be on the lookout for acquisitions, we see limited near-term catalysts. Should credit markets worsen, we believe its key attraction of 100% payouts could be compromised by the funding of sizeable acquisitions. Valuation of 14x CY09 P/E is not attractive enough against peers and its muted growth.

• Maintain Underperform; target price reduced to S$2.38 from S$2.61, following our earnings downgrade. Our target is still based on blended valuations. A shareprice re-rating is likely only in 2H09, probably triggered by an improved Aerospace.

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