STEng – OCBC

Resilient Earnings

Management confident of a stronger 2H11. We recently caught up with the management of Singapore Technologies Engineering Ltd (STE) to get an update on the group. STE historically has a stronger second half of the year, compared to the first half. Barring unforeseen circumstances, management is confident this will also be the case in 2H11. With STE’s 1H11 net earnings meeting 47.4% of our FY11 estimates, STE looks on track to meet our FY11 expectations, despite a weakening US$.

Earnings model fine-tuned. Nevertheless, our earnings model has been fine-tuned to further segregate STE’s four main segments into their respective sub-segments for greater granularity. (See Exhibits 1 to 5 for a graphical representation of the revenue and pre-tax profit contribution of STE’s four main segments and the respective sub-segments.) Despite this fine-tuning exercise, we have maintained our FY11 earnings estimate of STE at S$510m.

Risks and downside protection. Equity markets around the world have seen higher volatility in recent weeks and talks of the global economy heading for a recession is gathering pace, as investors are more unsure about the near-term outlook. During the equity sell-off in early 2009 caused by the global financial crisis, STE’s implied forward P/E fell by more than two standard deviations below its historical average. However, STE’s earnings are resilient in nature. STE has 1) a large stable stream of revenue coming from government-related projects; 2) a strong order book and a sizeable chunk of its non-government business under long-term contracts; and 3) a profitable and extremely cash generative business model. Furthermore, STE’s 90% dividend payout policy gives it a high dividend yield of 5.1%. These four factors collectively provide good downside protection, making STE a good name to own if one wants to stay invested in equities. At the current price of S$2.95, STE is priced at 17.0x P/E based on our earnings estimates over the next four quarters. This means STE is already trading at more than one standard deviation below its historical average forward P/E of 19.4x. (See Exhibit 6 for STE’s historical average forward P/E.)

Maintain BUY. Given STE’s resilient earnings, we used its historical average forward P/E of 19.4x against its net earnings estimates over the next four quarters to arrive at a fair value of S$3.37 per share, down from S$3.58 previously. As the new fair value still represents 14.2% upside, we maintain our BUY call.

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