Unexciting quarter

• Below expectations. 2Q09 net profit of S$109m (-9% yoy) was 10% below our expectation and 14% below consensus. The shortfall was mainly due to lower-thanexpected interest and investment income. 1H09 net profit of S$194m forms 43% of our FY09 forecast and 42% of consensus. STE announced an interim dividend of 3 Scts, the same as in 1H08.

• Aerospace rebounded from 1Q09 but margins remained weak. 2Q09 PBT of S$61m (-18% yoy) rebounded from S$40m in 1Q09, thanks to the lack of one-off financial costs on interest-rate swaps and better efficiency in PTF conversion programmes. 2Q09 PBT margins shrank 3% pts yoy to 12%, due to: 1) a weak US$; 2) lower investment income; and 3) an unfavourable sales mix with lower component sales. Management guides for a better 2H09 as the B757 PTF programme for FedEx is expected to turn profitable by end-2009 with another seven aircraft for delivery.

• Flat FY09; order book unexciting. Management expects higher PBT for Aerospace and Electronics in 2H09, offset by weaker Marine and a flat performance from Land Systems. Overall turnover and PBT for FY09 are expected to remain flat yoy. Order book slipped by 3% qoq to S$10.7bn in 2Q09. YTD announced contracts were lower at S$465m (S$680m in 1H08). Competition for contracts in the aviation industry remains stiff due to the economic downturn and aircraft capacity cuts. While we believe an improving macro environment could ease the pressure in the aviation sector, we believe it could take another 12 months before orders pick up.

• Lower net cash. Net cash dropped to S$198m in 2Q09 from S$482m in 1Q09. We believe the recent US$500m raised from a 10-year bond could be used to fund working capital needs and M&As. We see a re-rating of the stock only if earningsaccretive acquisitions are made. There have been no major M&As since the acquisition of BR Lee in the US in 2006.

• Maintain Underperform and target price of S$2.38, still based on blended valuations. As management has guided for a stronger 2H09, we have kept our earnings estimates intact. Valuation of 16x CY10 P/E looks rich against its generally flat outlook and uncertainties in the aviation industry.

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