Weak quarter, lacks near-term catalysts

• Below expectations. 4Q08 net profit of S$85m (-42% yoy) is 33% below our estimate and 31% below consensus. The weakness was due to impairment in the value of long-term quoted investments in Electronics and Land System amounting to S$23m and higher-than-expected provisions for doubtful debts of S$22m. 4Q08 net profit also included a tax write-back of current and deferred tax of S$18m. Stripping out the tax reversal, 4Q08 net profit would have been S$67m or 47% below our estimate, while FY08 net profit would have been S$434m or 15% below.

• Expect continued weak margins for Aerospace. 4Q08 PBT of S$43m (-51% yoy) for Aerospace was 45% below our expectation mainly due to lower-than-expected contributions from associates on lower volume and higher-than-expected provisions for doubtful debts. FY08 PBT margin was only 14% (FY07: 19%). We believe the weakness could persist into FY09 on lower MRO volume due to a challenging aviation industry, higher depreciation expense and losses from PTF conversion projects in 1H09.

• Outlook for FY09. Management expects group turnover to be higher in FY09 and comparable PBT. While Aerospace PBT is expected to be stable, the remaining divisions are expected to perform better. Management is hopeful about defence exports citing high enquiries. Order book was a record S$10.6bn (FY07: S$9.5bn) with about S$3.6bn for recognition in FY09.

• Earnings estimates cut by 9-11% for FY09-10, to reflect guidance. We lower our utilisation rate and margin assumptions for Aerospace and sales growth expectations for Land and Marine. We also introduce FY11 estimates.

• Lack near-term catalysts. STE remains in excellent health with net cash of about S$200m. It has also maintained its 100% dividend payout with a total of 15.8cts declared for FY08. While management continues to be on the lookout for acquisitions, we see limited near-term catalysts. Should credit markets worsen, we believe its key attraction of 100% payouts could be compromised by the funding of sizeable acquisitions. Valuation of 14x CY09 P/E is not attractive enough against peers and its muted growth.

• Maintain Underperform; target price reduced to S$2.38 from S$2.61, following our earnings downgrade. Our target is still based on blended valuations. A shareprice re-rating is likely only in 2H09, probably triggered by an improved Aerospace.

Dividend concerns unfounded

Excluding one-off impairment charge in 4Q08, FY08 net profit of S$473.6m (down 6%) was in line with our expectations. Allaying market concerns, ST Engineering declared a 100% dividend payout, amounting to 15.8cts per share for FY08. While a record orderbook of S$10.6b secures 60-70% of FY09 revenues, headwinds in aerospace sector will continue to be a drag on earnings. We lower our EPS forecasts for FY09 and FY10 by about 8% each. However, gross cash level above S$1b and strong free cash flow generation of close to S$500m per year should help STE sustain its dividend payout record, translating to a dividend yield of 7.5% Maintain BUY, TP reduced to S$2.50.

4Q08 earnings hit by one-off items. 4Q08 PBT came in at S$89m (down 38% y-o-y), largely due to the impairment of three equity investments worth S$23m (two in Electronics, one in Land Systems) and a S$31.7m allowance for doubtful debts related to the bankruptcy of aerospace customers, Sterling and EAMS. Net profit of S$102m was boosted by a tax credit of S$18m.

Weaker performance in key sectors. Apart from provisions for doubtful debt, aerospace segment PBT of S$272m (down 20% y-o-y) was hit by high depreciation charges on new facilities, prototyping costs for PTF conversions and a weak US$ impact of S$19m. Marine revenues and margins were weak as major revenues from the frigate program were booked in FY07 and losses were recognised on a contract signed last year.

Dividend yield secured by record orderbook. Risk to the orderbook is minimal as defence and government related projects make up more than 50%. The Group is also expected to be a key beneficiary of the increased government spending on infrastructure projects worldwide. Net cash of close to S$200m and strong operational cashflows indicate dividend sustainability and a yield of 7.5% at current trough valuations. Maintain BUY, at a reduced TP of S$2.50.

Cautiously optimistic despite turbulence

Better than expected if certain items were excluded. In the year to Dec 08, ST Engineering’s (STE) net profit came off by 5.9% to S$473.6m on the back of a 5.8% increase in revenue to S$5,344.5m. Full year net profit had fallen short of our estimates at S$514.2m, although we note that it would have came in at S$529m and beaten our expectations should the S$25.9m impairment of investments and the S$29.5m allowance for doubtful debts be excluded.

Still expecting comparable earnings in FY09 despite the current economic turmoil. With its order book at a record S$10.6b (of which S$3.6b would be fulfilled in FY09), management highlighted that its mixture of commercial and government contracts would serve as a good buffer in this current downturn, especially so given that the various countries are implementing their respective stimulus packages to make up for the shortfall in private sector spending.

Furthermore, STE’s extensive geographical reach would also ensure that the risks pertaining to protectionism issues – as the various governments attempt to restrict spending to their own countries – are kept low. Additionally, we also note that STE’s exposure to new markets, which have been less affected by the current downturn, have also been steadily increasing.

Earnings and target price revision. Given the tepid economic outlook, we have reduced our FY09 earnings by 18% to S$465.2m (-1.8% YoY). We have also introduced FY10 earnings, which we estimate to grow 10.9% to S$516.0m. At S$2.06, STE is trading at 13.3x FY09 and 12.0x FY10 P/E, which is at the lower end of the trading band. Assuming that the Group keeps to its 100% payout, dividend yield remains attractive at 7.5 – 8.3% for the next two years. Based on our DDM, we attain a price target of S$2.47 (previously S$2.83), suggesting a 19.8% upside from current levels. The new target price implies a prospective P/E of 15.9x, lower than the 5–yr average of ~20x. Maintain BUY.

ST Engg Q4 profit down 30%

Full-year earnings dip to $473.6m, due to doubful debts, impairment charge

ST Engineering’s net profit for the fourth quarter ended Dec 31 has fallen 30.1 per cent to $102.3 million, from $146.4 million a year earlier.

However, sales rose 3.8 per cent year on year to $1.35 billion, from $1.3 billion in the same quarter last year.

For the full year, ST Engg made a net profit of $473.6 million, down 6 per cent from $503.5 million, even though turnover was up 6 per cent at $5.34 billion from $5.05 billion previously.

Much of the hit was due to an impairment charge of $23 million for quoted securities, while the company also made a net allowance of $32.4 million for doubtful debts.

Full-year diluted earnings per share came to 15.74 cents, down 7 per cent from 16.91 cents for FY2007. The company declared a final dividend of 12.8 cents to take full-year payout to 15.8 cents, or 100 per cent of net profit, as has been the custom.

Chief executive officer Tan Pheng Hock said that ‘definitely, the scale and size of (potential) acquisitions will affect’ future dividend payouts but said that the company, which has a triple-A rating, would prefer to take on debt for any new purchase.

Mr Tan noted that the company still had cash and cash equivalents of $1.05 billion, with net cash from operating activities of $511.4 million.

Meanwhile, the company has withdrawn all its money from fund managers, and so will not likely take any hit if markets head further south. It has also ‘very liquid’ cash parked with associated companies in the Temasek Holdings stable, which can be drawn on within two months, Mr Tan said.

All its business segments reported lower profits for the full year, except for Land Systems. Aerospace was the second-hardest hit, after Marine, with pre-tax profit falling 20 per cent, to $272.1 million.

The aerospace business accounts for about half of group earnings and had been hurt by unfavourable exchange rates, higher depreciation, more doubtful debts following the bankruptcies of two clients in the last quarter, and lower contribution from its component and engine repair/ overhaul business group.

Mr Tan said that the company’s strong order book – $10.6 billion at the end of last year, with $3.63 billion of that due this year – would afford it ‘operating leverage to weather an uncertain 2009’. However, ‘a drastic deterioration in our operating environment would affect our performance.’

Otherwise, the company expects higher sales and comparable pre-tax profits this year compared to last, he said.

Mr Tan also disclosed that ST Engg would save about $20 million from the recently announced one percentage point cut in corporate tax rates and the Jobs Credit scheme and said that there were no plans to lay off staff in Singapore.

ST Engg shed 13 cents or 5.9 per cent to close at $2.06 yesterday, its lowest since late October.