Poised for re-rating

• Wins S$710m 5-yr contract from US Army
• Land Systems will drive revenue growth in FY10, Aerospace expected to recover
• Upgrade to BUY, TP revised up to S$3.10
• FY09 dividend yield of 5% will provide support

Sizeable contract win. ST Engineering’s US-based Land Systems subsidiary, VT Miltope, has won a 5-year US$500m (~S$710m) contract to supply automatic test systems to the US Army. The 5-year Indefinite Delivery Indefinite Quantity (IDIQ) contract will allow the US Army the flexibility to acquire items like rugged laptops, test equipment and instruments, within stated limits.

Land Systems will drive revenue growth. The announcement takes the value of new contract wins announced in 2H09 to more than S$1.1bn, and comes on top of its existing S$10.7bn orderbook as of end-
2Q09. Along with the expected commencement of deliveries of the Bronco All Terrain Carriers to the UK Ministry of Defence from end-2009, this contract will further boost the performance of the Land Systems
sector in FY10 and FY11. The Aerospace segment will be the other key earnings driver in FY10, with margin recovery on track, as PTF conversions turn profitable. We have revised up our FY10 EPS estimates by about 2.6%.

Laggard for too long. The stock has underperformed the STI by 32% since April’09, and current valuation premium to STI Index of less than 10% is much lower than historical average PE premium of 40%. We believe this narrowing is unsustainable – given STE’s superior cash flow generation, defensive earnings base and 100% dividend payout record – and upgrade the stock to BUY at a revised TP of S$3.10 (20x FY10 earnings, compared to STI trading at 15x FY10). Dividend yield is a healthy 5.0% and further catalyst may be in the form of M&A funded by its recent medium term notes issuance.

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