STEng – CIMB

MRO and defence myths busted

In our recent roadshow to Hong Kong, STE busted a few myths, includingthat of lower MRO demand fromnew aircraft joining the aviation industry and the adverse impact of cuts in global defence budgets on STE’s defence business.

Maintain Outperform with anupgradedtarget priceafter rollingforward our blended valuations (19x CY14 P/E, dividend yieldsand DCF). We like STE for its S$630m war chest, above-peers ROEsof 30% and generous payouts of 90%, sustaining yieldsat5%. Catalysts include M&As and stronger Aerospace margins.

What Happened

During our road show, management clarified that although newer planes could be equipped with higher composites that would require lessermaintenanceofairframes, the bulk of the global fleet is still built on older technologies,making MRO an integral expense foroperators. Secondly, STE is gaining MRO market share in the US,thanks to anexodusof competitorssuch asAir Canada’s in-house MRO, Aveos, PEMCO World Air Services, American Airlines’s internal MROand Aviation Technical Services.Finally,STE’s proven capabilities indifferentclassesof aircraft could allow the group to capture strong demand for freighters.Airbus forecasts that about 1,800 conversions would be needed by 2022.

STE derives itsdefence business mainly from itsLand Systems division, where Singapore accounts for about 60% of the revenue. Singapore’s defence budget has been growing steadily at a 4.1% 10-year CAGR, and should continue to provide a baseload to STE.

What We Think

Having expanded its order book by 30% to a record S$12.7bnsince the GFC, we think STE has emerged more defensive, withAerospace, Electronics and Marine nowbetter prepared for downturns. STE’s net cash bodes well for its search for M&As. We expect some successful earnings-accretive M&As byAerospace, Marine and Electronicssoon, going bySTE’s aggressive hunt for bargains.

What You Should Do

Stay invested.STE ranks among the top-15 dividend-yield companies in Singapore,ex-REITs. Its premium valuations are largely predicated on its dividend payouts, which we believe aresustainable.