Partners DCNS for major US defence project

Company Overview

ST Engineering (STE) is an integrated engineering group with exposures to four key business segments: Aerospace, Marine, Electronics and Land Systems. The company is also an anchor customer of Singapore’s defence industry.

• STE partners DCNS for the USCG OPC contract
  
• Long gestation period for the project
  
• Greater clarity on the project when the USCG awards the initial contracts to three shipyards in 2013
  
• Maintain Accumulate with unchanged TP of S$3.40
  

What is the news?

STE recently announced that their US based subsidiary, VT Halter Marine (VTHM), signed a partnership agreement with DCNS to submit a proposal to the Department of Homeland Security (DHS) for the design and construction of the US Coast Guard (USCG) Offshore Patrol Cutter (OPC). According to STE’s press release on the collaboration, VTHM would be the prime contractor and DCNS would be the exclusive subcontractor for the OPC platform design.

How do we view this?

According to the details disclosed by the USCG, there were 7 shipyards that had expressed interest in this project as of July 2012. Our research suggests that at least four of the shipyards have a history of business dealings with the USCG. Hence, we expect competition for this contract to be stiff. We believe that there should be greater clarity on the project when the USCG awards the initial contracts to three shipyards in 2013.

Investment Actions?

We remain positive and expect potential contract wins to catalyze the stock. Despite a significant rally since the start of the year, STE would still yield >4% on our estimates. Pending the release of STE’s results in early November, we kept our recommendations and estimates unchanged. Accumulate.

DEFENSIVE PLAY WITH ROOM TO CLIMB

• Mid-cycle multiple
  
• Order book may surpass S$13b
  
• Increasing earnings visibility
  

Share price can climb further

A safe haven in turbulent times, STE has outperformed the STI significantly since the beginning of the year, rising 29.0% versus the 15.6% increase by the index. The stock reached its 52-week high of S$3.55 last Friday. The counter is trading at a historical P/E multiple of 20.1x and should still have room to climb (about half a standard deviation above 10-year average). STE’s earnings are fairly stable given its four main diversified businesses, which help to reduce its exposure to sector-specific risks. With an attractive FY12F dividend yield of ~4.8%, STE should continue to perform in today’s uncertain but liquidity-rich global economic environment.

ST Marine wins S$179m worth of contracts

It has recently been announced that ST Marine has secured shipbuilding and repair contracts worth ~S$179m. These wins include a contract to build two additional Offshore Support Vessels (OSVs) for Hornbeck Offshore Services, LLC, as well as a series of repair and upgrading projects. With STE’s order book standing at S$12.9b as of end-1H12, we think that it may be greater than S$13b by the end of 3Q12 and expect continued order book growth.

Looking further into the future

We think it is worthwhile noting that STE’s order book clocked at the end of each year has on average grown faster than the following year’s annual revenue. The order book grew 16% p.a. between end-2005 and end-2010 from S$5.38b to S$11.5b while annual revenues grew 6% p.a. between FY06 and FY11. This trend probably suggests that the average tenure of order book contracts has been increasing. The fact that the order book has been growing faster than revenue implies increasing earnings visibility into the future.

Raise fair value to S$3.81

Rolling forward our valuation to blended 2H12/1H13 EPS and increasing our P/E multiple from 20.0x to 20.5x, we raise our fair value from S$3.50 to S$3.81 and maintain a BUY.

When the Tough Keep On Rollin’

A shield against global worries. Recent contract wins have helped cement our view that STE remains one of the top defensive picks for investors concerned about global macro uncertainties. STE’s strong orderbook, helped in no small way by its defence contract capabilities, provides earnings visibility and supports an attractive forward dividend yield of 5-5.5% p.a. Our BUY call has worked out quite well since our upgrade in April, with a ~10% total return on investment. With a target price of SGD3.78 pegged to mid-cycle valuations of 19x FY2013 PER and the best yet to come, we maintain our BUY call.

FY2012 in the bag; FY2013 looking good. SGD179m in contracts recently announced by ST Marine reaffirms strong contract win momentum despite the tough economic conditions. This brings its total orderbook closer to SGD13b, of which ~SGD2.5b (40% of our FY2012 revenue forecast) is expected be booked in 2H2012. With 1H2012 revenue of SGD3.1b (50% of FY2012 forecast), we believe our FY2012 revenue forecasts are in the bag. As we expect the strong momentum to continue, FY2013 is also looking good.

Conservative margin assumption suggests upside to earnings. We have assumed a 9% net margin for our FY12-14 forecasts, but there may be upside potential as these are conservative assumptions that mirror operating conditions immediately after the Great Financial Crisis of 2008-09. STE’s earnings resilience comes from diverse businesses that help shield it from sector-specific shocks. Historically, they have given earnings a complementary mix of stability and profitability.

The cycle is still on STE’s side. We believe Aerospace and Marine still have upside in their respective cycles, as the aviation MRO industry is expected to benefit from the proliferation of airline capacity, and high oil prices are keeping activities in the offshore sector positive. For Electronics, government initiatives to enhance the local rail transport network are improving contract win visibility, while Kinetics will continue to be underpinned by steady defence-based contracts.

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.

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.