STEng – BT

Minimal impact from LDA termination move

Termination notice for Ropax. ST Engineering (STE) announced that its marine arm – ST Marine (STM) – has received a notice of termination from Louis Dreyfus Armateurs (LDA) regarding the shipbuilding contract for the Roll-on/Roll-off Passenger ferry (Ropax); LDA is alleging that there is a delay in the delivery of the S$179m vessel. As a recap, LDA placed the order (worth S$168m then before add-ons) in Jul 2007, with construction to start in 1H08 and delivery in 1H10; the 4,000-dwt Ropax ferry measures about 161m long and 25.6m wide, and will operate in the English Channel for day and night crossing. LDA also alleges that there is a deficiency in the deadweight capacity.

No material impact on financials. In the event that the notice is valid, STM is required to refund the milestone payments made by LDA (amounting to S$129m plus interest); but STM maintains that under the contract, its total liability is capped at 10% of the contract price. In any case, STM has referred the matter to its legal advisers; STE also does not expect the contract termination to have any material impact on its NTA or EPS for FY11. In any case, we note that the milestone payments (excluding interest and damages) are just 2.2% of STE’s FY10 revenue, and we also understand that the group has been making provisions for this particular vessel since missing the stated delivery date.

Sell or lease vessel when completed. Meanwhile, we understand that the group is going ahead with the completion of this vessel; hence even if the contract is terminated, STE has the option of either reselling it in the secondary market or chartering it out to third party operators. However, as the Ropax may be highly customized, there is a slight risk that STE may need to refit the vessel or face a longer time before it can find a suitable buyer or charterer. But from recent transaction reports from shipbrokers, we understand that the demand for RoRo (Roll-on/Roll-off) vessels remains relatively buoyant.

Maintain BUY. Currently, it is still early days to assess if STE/STM has to pay damages etc, hence we hold off adjusting our FY11 estimates; our worst case scenario could see a <5% impact on FY11F pre-tax profit. We are still positive on the group’s overall prospects, defensive nature and do not believe that this incident will affect its strong payout (around 90% of core earnings) ability; hence we maintain our BUY rating and S$3.71 fair value (21x FY11F EPS).

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