Learning costs proving costly

Story: Though net profit of S$129m (up 2.7% y-o-y) was in line with our expectations, PBT (-6% y-o-y) was below. Net profit was buoyed by a one-time deferred tax credit of S$16.8m. A dip in investment income, higher depreciation costs and prototyping losses from Passenger-to-Freighter (“PTF”) conversions (loss of S$15m in 9M08) in the aerospace segment led to the underperformance.

Point: Aerospace margins continued to slide (-4.4 ppts to 14.5%) and apart from the PTF learning cycle losses, the recent bankruptcy of European customer Sterling Airlines is likely to affect PBT further by at least S$10m over the next 2 years. Revenue from the Marine segment was also down 20% owing to lower shipbuilding revenue. However, both the Electronics and Land Systems segments delivered strong y-o-y revenue growth (+25%), lifting overall 3Q08 revenue by 12%. Profit from Land Systems was impacted, though, by slow auto sales in the US and impairment of a long-term investment. Carrying value of investments at Group level were marked down about 50% to S$22m from S$41m at end-FY07.

Relevance: The outlook for the MRO sector, especially in the US, remains gloomy in the wake of an aviation slowdown and shipbuilding/ shiprepair revenue growth is also likely to be stymied in FY09. We expect the other segments to register decent growth on the back of government spending in transport projects, infrastructure and defence. Overall, we cut FY08 earnings by 3% and FY09 earnings by 5%, as management further lowered guidance to “lower PBT in FY08” vs. “flat PBT growth” previously. Given its defensive reputation, the stock has held up well amidst the recent market turmoil and upside is limited at our unchanged target price of S$2.80.

Maintain HOLD. A robust orderbook of S$9.5b and 7% FY09 dividend yield backed by S$1b cash equivalents, limits downside risks.

Lacklustre; more weakness ahead

• Largely in line, lifted by tax write-back. 3Q08 net profit of S$129m (+3% yoy) was largely in line with our estimate and consensus. Results were lifted by a S$17m tax write-back of deferred tax asset adjustments during the quarter. Without the tax reversal, net profit would have been S$111m, only 22% of our full-year forecast mainly due to Aerospace weakness. 9M08 net profit of S$371m (+4% yoy) represents 72% of our FY08 forecast.

• PBT dragged down by weaker Aerospace. 3Q08 PBT of S$144m (-6% yoy) was mainly affected by lower contributions from Aerospace. The weakness in Aerospace was due to: 1) a depreciating US$; 2) learning-curve costs for PTF conversions of B757-300 and B767-300; and 3) higher depreciation from increased capex. Aerospace PBT margins dropped to 15% (3Q07: 19%) as a result.

• Profit guidance lowered; more bankruptcy filings by customers. Management now flags a weaker PBT and marginally weaker PATMI for FY08 (previous quarter’s guidance was for a comparable FY08). Separately, STE announced that its customers, Sterling Airlines and Essential Aircraft Maintenance Services, had filed for bankruptcy. STE estimates the earnings impact from these customers at S$10m.

• Earnings estimates cut by 4-16% for FY08-10. Reflecting the disappointing 3Q08 results and weaker guidance, we have cut our FY08 earnings by 4% as we lower our margin expectations for the Aerospace division. We also cut our FY10-11 earnings by 16%, with slower growth assumed for all divisions.

• Balance sheet healthy but weak near-term growth prospects. Fundamentally, STE remains in excellent health with net cash of about S$600m. Order book is S$9.5bn (up from S$9.3bn in 2Q08). However, trading at 15x CY09 P/E given its muted earnings growth and uncertainties from the global economy, the stock is not cheap.

• Downgrade to Underperform from Outperform; target price reduced to S$2.61 from S$3.39, taking into account our earnings downgrade and rolling forward our target to CY10 in our blended valuation. A share price re-rating is likely only in 2H09, probably triggered by an improved Aerospace performance.

ST Engg posts 2.7% rise in Q3 earnings to $128.9m

Turnover up 11.8%, of which 66% were commercial sales

SINGAPORE Technologies Engineering has reported a 2.7 per cent increase in net profit to $128.9 million for its third quarter ended Sept 30, as turnover rose 11.8 per cent to $1.38 billion.
Commercial sales accounted for 66 per cent ($918 million) of turnover. Earnings per share were 4.31 cents, up from 4.24 cents a year earlier.

The group’s order book grew to $9.54 billion from $9.29 billion at June 30, with $1.25 billion of orders to be delivered in the current Q4. At end-September, cash, cash equivalents and funds under management totalled $1 billion.

For the nine months to Sept 30, profit grew 4 per cent to $371.3 million on 6.5 per cent growth in turnover to $3.99 billion.

ST Aerospace, which contributed 48 per cent of group profit, saw net profit slide 10 per cent to $61.6 million, despite revenue rising 13 per cent to $501 million.

The drop in profit was due to foreign exchange losses arising from the US dollar, higher passenger-to-freighter aircraft prototyping costs and higher depreciation resulting from investments in new capabilities and capacity.

In addition, Sterling Airlines and Essential Aircraft Maintenance Services – customers of ST Aerospace subsidiary ST Aerospace Solutions (Europe) – filed for bankruptcy on Denmark. The contract to support

Sterling Airlines was worth about $45 million over three years from 2007. And the impact of the bankruptcy filings on pre-tax profit could be $10 million ‘on a conservative basis’.

ST Aerospace president Tay Kok Khiang said the company is in a good position to weather a short-term slide in the aviation industry thanks to its strong customer base, diverse offerings and market position.

Q3 turnover for the ST Engineering’s land systems sector was $333 million or about 25 per cent higher year-on-year, helped by stronger exports by its munitions and weapons group.

But net profit plunged 20 per cent to $13 million, dragged down partly by a poorer performance in the auto segment.

ST Electronics contributed revenue of $298 million, a jump of 26 per cent from Q3 2007, as its three business groups – large-scale systems, communication and sensor systems, and software systems – completed various projects. But net profit was 2 per cent lower at $21.7 million as margins fell.

Although net profit for the marine sector was 7 per cent higher at $16.5 million, revenue took a hit, dropping 20 per cent to $205 million in Q3 from $256 million a year earlier. The stronger profit reflected a favourable sales mix and lower expenses, while weaker demand for conversion services contributed to the fall in revenue.

‘Barring unforeseen circumstances, under a weaker global economic environment, ST Engineering still expects to achieve modestly higher turnover, though a lower profit before tax and a marginally weaker Patmi (profit after tax, minorities and interest) in FY 2008 than FY 2007,’ ST Engineering said in a statement.