Healthy earnings momentum

• 2Q12 net profit of S$143m (up 10% y-o-y) slightly ahead of our estimates; margin improvements across all segments

• Orderbook at record level of S$12.7bn underpins earnings visibility, going forward

• Maintain BUY with higher TP of S$3.60

Highlights

Another strong quarter. 2Q12 net profit of S$143m was slightly above our expectations of S$138m, even after adjusting for S$12.8m gains on the sale of investment property, which was largely offset by S$10m allowance for doubtful debts. Revenue was up 10% y-o-y and 7% q-o-q to S$1.57bn, driven largely by the Land Systems and Marine sectors. 1H12’s net profit of S$277.5m makes up 50% of our existing full-year estimates for FY12, which is ahead of usual seasonality.

Margin improvement across all sectors. Overall PBT margin improved sequentially to 12% in 2Q12 from 10.5% in 1Q12. Aerospace core PBT margin was strong at 15%, compared to 13% in 1Q12 and 13.5% in 2Q11, owing to a favourable sales mix (higher heavy maintenance sales). Shipbuilding margins in the Marine segment also improved, despite an unfavourable fair value change of embedded forex derivatives in the S$880m Oman navy contract, which is denominated in Euros.

Our View

Record orderbook provides healthy earnings visibility. STE won close to an estimated S$2bn worth of new orders in 2Q12, as its orderbook expanded to record level of S$12.7bn at end-2Q12 from S$12.2bn at end-1Q12. About S$2.5bn of its orderbook will be recognised in 2H12.

Recommendation

Maintain BUY. Despite some acquisitions-related hiccups in the recent past, STE’s growth trajectory seems to be on track, driven by healthy order-win momentum and improvement in margins. We revise upwards our FY12/13F earnings estimates marginally by about 1-1.2% to account for the above. Operating cash flows in 1H12 remained strong, driven by higher customer deposits, in line with healthy order wins. Interim dividend of 3Scts was declared, at par with 1H11 levels. Given visible earnings growth, strong balance sheet and healthy dividend yield of 5%, we maintain our BUY call. Our TP, which is based on the blended valuation methodology, is revised upwards to S$3.60 as our PE multiple is revised upwards to 18x to reflect mid-cycle valuations.

Record high order book

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.

• 9.7% increase in PATMI boosted by one-off divestment gains of S$13.2mn
  
• Record high order book of S$12.7bn (2.1X sales)
  
• Interim dividend of 3.0cents declared
  
• Maintain Accumulate with revised TP of S$3.40
  

What is the news?

STE recorded profit growth of 9.7% driven by higher sales from all segments except Aerospace. The Group’s EBITDA margin was stable at 12.9% (2QFY11: 12.6%, 1QFY12: 11.8%). STE’s order book reached a record high at S$12.7bn (2.1X sales) after accounting for contract wins of c.S$2.1bn in the quarter. Management reaffirmed guidance for higher revenue and PBT for FY12E. Interim dividend of 3.0cents was declared.

How do we view this?

Even after adjusting for the S$13.2mn one-off gain on divestment of properties, STE’s underlying profit was strong with PBT growth of 4.4%. Core segmental performance for 1H12 remains on track to meet our full year estimates.

Investment Actions?

We tweaked our forecasts to adjust for the one-off gain on divestment of properties and maintain our Accumulate rating on STE. The stock’s earnings multiples remain below historical average at 18.5X FY13E.

STRONG ORDER BOOK LAYS 2H12 FOUNDATION

• 2Q12 results are in line
  
• Good performance by sectors
  
• Solid order book
  

Solid 2Q12 performance

ST Engineering (STE) posted 2Q12/1H12 results that were generally in line with consensus and our estimates. 1H12 EPS of 9.05 S cents formed 50% of ours and consensus’ estimates for FY12. STE’s 2Q12 revenue climbed by 6% YoY to S$1.57b and PATMI rose by 10% YoY to S$143.1m. All sectors, apart from Aerospace, posted higher revenues, and all sectors contributed higher pre-tax profits.

Generally healthy performance for sectors

While the Aerospace sector saw revenue declined 2% YoY to S$493m, partially due to unfavourable Euro translation and lower revenue from the engines division, its pre-tax profit increased 20% YoY to S$81.6m with improved EBITDA and a S$7.0m gain on the disposal of a property. Electronics performed well, registering a 2Q12 revenue increase of 9% to S$348m and a pre-tax profit increase of 17% YoY to S$41.8m, on the back of a favourable sales mix. Land Systems saw revenue and pre-tax profit climbed 11% and 6% YoY to S$389m and S$32.0m respectively; the latter included a S$5.8m gain on the disposal of a property. Land System’s EBITDA had fallen 12% YoY to S$33.5m due to an unfavourable product mix and higher operating expenses. Higher shipbuilding revenue helped to boost the Marine sector’s 2Q12 revenue by 7% YoY to S$277m and pre-tax profit rose 11% YoY to S$31.6m.

Enlarged order book to support 2H12

STE’s order book grew from S$12.2b to S$12.7b between end Mar and end Jun 2012. The size of the 2Q12 order book compares even more favourably to 2Q11’s order book of S$10.8b. To recap, in 2Q12, Aerospace secured S$370m of new contracts and its first VIP Boeing Business Jet maintenance check contract. Marine won a S$880m contract to design and build four patrol vessels for the Royal Navy of Oman. Management expects S$2.5b of STE’s order book will be delivered in 2H12.

Maintain BUY

Management is cautiously optimistic and continues to guide higher revenue and pre-tax profit for FY12 versus FY11. We maintain our fair value estimate of S$3.50/share and BUY rating on STE.

STRONG ORDER BOOK LAYS 2H12 FOUNDATION

• 2Q12 results are in line
  
• Good performance by sectors
  
• Solid order book
  

Solid 2Q12 performance

ST Engineering (STE) posted 2Q12/1H12 results that were generally in line with consensus and our estimates. 1H12 EPS of 9.05 S cents formed 50% of ours and consensus’ estimates for FY12. STE’s 2Q12 revenue climbed by 6% YoY to S$1.57b and PATMI rose by 10% YoY to S$143.1m. All sectors, apart from Aerospace, posted higher revenues, and all sectors contributed higher pre-tax profits.

Generally healthy performance for sectors

While the Aerospace sector saw revenue declined 2% YoY to S$493m, partially due to unfavourable Euro translation and lower revenue from the engines division, its pre-tax profit increased 20% YoY to S$81.6m with improved EBITDA and a S$7.0m gain on the disposal of a property. Electronics performed well, registering a 2Q12 revenue increase of 9% to S$348m and a pre-tax profit increase of 17% YoY to S$41.8m, on the back of a favourable sales mix. Land Systems saw revenue and pre-tax profit climbed 11% and 6% YoY to S$389m and S$32.0m respectively; the latter included a S$5.8m gain on the disposal of a property. Land System’s EBITDA had fallen 12% YoY to S$33.5m due to an unfavourable product mix and higher operating expenses. Higher shipbuilding revenue helped to boost the Marine sector’s 2Q12 revenue by 7% YoY to S$277m and pre-tax profit rose 11% YoY to S$31.6m.

Enlarged order book to support 2H12

STE’s order book grew from S$12.2b to S$12.7b between end Mar and end Jun 2012. The size of the 2Q12 order book compares even more favourably to 2Q11’s order book of S$10.8b. To recap, in 2Q12, Aerospace secured S$370m of new contracts and its first VIP Boeing Business Jet maintenance check contract. Marine won a S$880m contract to design and build four patrol vessels for the Royal Navy of Oman. Management expects S$2.5b of STE’s order book will be delivered in 2H12.

Maintain BUY

Management is cautiously optimistic and continues to guide higher revenue and pre-tax profit for FY12 versus FY11. We maintain our fair value estimate of S$3.50/share and BUY rating on STE.

Nera deal is off; moving on…

We are not disappointed that Nera’s shareholders have voted against STE’s proposed acquisition of the firm. Firstly, we estimate that the deal would have only contributed 2% to STE’s earnings. Secondly, we believe there other M&A targets in Asia.

No change to our EPS or target price (blended P/E, DCF, dividend yields). Our forecasts have not assumed contributions from the acquisition. No reason was disclosed but we suspect Nera’s remaining shareholders (49.95%) are hopeful of striking a higher offer price. Maintain Outperform on STE for catalysts from stronger pick up in MRO.

What Happened

The shareholders of Nera Telecommunications have voted against STE’s proposed acquisition of the firm (all the shares).The acquisition was first announced on 10 Feb12,whenSTEsaid that its subsidiary, ST Electronics, had received an irrevocable undertaking from Nera’s controlling shareholder, Eltek ASA (50.5%),in favour of the transaction. The offer price then was S$0.45/share (S$0.39 cash and S$0.06 dividend), amounting to S$141m.

Nera is a provider of products, solutions and services ranging from satellite communications and wireless infrastructure networks to Internet protocol, optical and broadcast network infrastructure.

What We Think

We believe Nera’s remaining shareholders are hoping for a higher selling price. Nera’s share price hit a high of S$0.50 on 10 Feb just before the announcement (after trading hours).

The proposed purchase price of 10x CY11 P/E appeared fair vs. STE’s valuation (16.5x) then. We think STE is unlikely to pursue the matter further and is likely to move on to other M&A targets.

We are not extremely disappointed. Nera is “good to have”, given a clean balance sheet and potential synergies, but is not imperative to the group as we estimate only a 2% earnings contribution.

What You Should Do

Stay invested as STE is still trading close to its trough of 15xP/E in the last five years.