Another Growth Engine

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.

• US$49.7mn for certain assets of Pemco

• 320k sqm of space, 1.4mn manhours of capacity, 2 hangars

• B737 freighter conversion certificates acquired

• 16% increase in Group capacity

• Maintain Accumulate with unchanged TP of S$3.37

What is the news?

STE announced the acquisition of certain assets of Pemco as part of a bankruptcy proceeding. STE’s US arm VT Aerospace would assume liabilities of US$6.2mn and pay a consideration of US$49.7mn for the Tampa facility and certain assets of PEMCO. The acquisition is contingent upon the approval by the US Bankruptcy Court and is expected to be completed in July 2012. The facility occupies 320k sqm of hangar and office space at Tampa International Airport in Florida and is seen as a gateway to Latin America. STE would also acquire the Boeing B737 freighter conversion Supplemental Type Certificates from Pemco in this deal.

How do we view this?

We view this development positively as it would further extend STE’s lead as the world’s largest MRO player. This deal would increase STE’s heavy maintenance capacity by 16% and increase its exposure to the fast growing Latin American region. While it is difficult to judge as to whether STE overpaid for the assets due to the lack of financial disclosures, bankruptcy proceedings usually throw up assets at a reasonable price.

Investment Actions?

We kept our forecasts unchanged and maintain our Accumulate rating on STE. STE’s earning yield spreads and P/E multiples remain below historical averages, reflecting undervaluation in this defensive stock, in our view.

Another Growth Engine

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.

• US$49.7mn for certain assets of Pemco

• 320k sqm of space, 1.4mn manhours of capacity, 2 hangars

• B737 freighter conversion certificates acquired

• 16% increase in Group capacity

• Maintain Accumulate with unchanged TP of S$3.37

What is the news?

STE announced the acquisition of certain assets of Pemco as part of a bankruptcy proceeding. STE’s US arm VT Aerospace would assume liabilities of US$6.2mn and pay a consideration of US$49.7mn for the Tampa facility and certain assets of PEMCO. The acquisition is contingent upon the approval by the US Bankruptcy Court and is expected to be completed in July 2012. The facility occupies 320k sqm of hangar and office space at Tampa International Airport in Florida and is seen as a gateway to Latin America. STE would also acquire the Boeing B737 freighter conversion Supplemental Type Certificates from Pemco in this deal.

How do we view this?

We view this development positively as it would further extend STE’s lead as the world’s largest MRO player. This deal would increase STE’s heavy maintenance capacity by 16% and increase its exposure to the fast growing Latin American region. While it is difficult to judge as to whether STE overpaid for the assets due to the lack of financial disclosures, bankruptcy proceedings usually throw up assets at a reasonable price.

Investment Actions?

We kept our forecasts unchanged and maintain our Accumulate rating on STE. STE’s earning yield spreads and P/E multiples remain below historical averages, reflecting undervaluation in this defensive stock, in our view.

ST KINETICS FILES WRIT PETITION

•ST Kinetics seeks reversal of debarment

•STE maintains innocence

•India debarment has no impact

ST Kinetics seeks to negate debarment

ST Engineering (STE) last Friday announced that its subsidiary ST Kinetics (STK) has filed a writ petition with the High Court of Delhi in New Delhi, naming India’s Ministry of Defence and Ordnance Factory Board (OFB) as respondents. With the filing of the writ petition, STK is seeking to negate an OFB debarment order that prohibits STK from ‘further business dealings with the OFB for a period of 10 years.’ To recap, the OFB debarred a number of defence companies, including STK, from doing business in India after evidence of illegal gratification to officials, including Sudipto Ghosh, the former Director General of the OFB.

STE maintains innocence

Since news of the debarment broke out, STE has maintained its innocence and sought to clear its name of any shenanigan. In addition, STE disclosed that STK has never won any defence contract or exported defence sales to India, since developing defence export sales is usually a long process. Thus, STE has not included any expected sales to India in its FY12 guidance. Furthermore, STE’s recent ~S$880m contract win to build patrol vessels for the Royal Navy of Oman, demonstrated its ability in winning defence contracts has not been compromised by the India debarment.

Minimal negative impact

With the vigorous insistence of its innocence, STE’s ability to win defence-related contracts is unlikely to be diminished and the likelihood of its share price taking a big hit from this issue is low. In addition, STE has explicitly said the debarment has no impact on its financial performance and maintains its FY12 guidance. However, STE’s attempt to reverse the OFB debarment order, even if successful, will require many years’ time and effort.

Maintain buy

We maintain our fair value estimate of S$3.50/share and BUY rating on STE.

A boost to P2F conversion pipeline

A330 P2F programme on track. ST Engineering announced the finalisation of agreements with Airbus and its parent EADS to collaborate on the A330 Passenger-to-Freighter (P2F) conversion project. The initial agreement had been announced during the Singapore Airshow earlier in February. Under the final agreement, ST Engineering will invest about Euro 110.5m (S$186.6m) for a 35% effective stake in EADS EFW, the P2F conversion arm of EADS. EADS will hold the remaining 65% and will also have a call option over STE’s 35% stake during the engineering development phase of the A330P2F programme. The call option will expire when the engineering work is successfully delivered to EADS EFW. The engineering phase is expected to commence by end-2012.

ST Aerospace will be the engineering lead. ST Aerospace, with its engineering design experience, will be the lead during the engineering and development phase, while EADS will be the lead in terms of actual modifications and marketing. Most of the conversion works will be done at EADS EFW’s facility in Dresden, Germany, with the remainder coming to a dedicated ST Aerospace facility. The first converted aircraft is expected to come into service by 2016, with airlines like Qatar Airways already showing an interest in the programme. The larger A330-300P2F will be targeted at cargo integrators, while the A330-200P2F will be optimised for higher-density freight and longer-range performance.

Expands capabilities, potentially boosts associate profits. If this programme is successful, ST Aerospace will be the first independent MRO to have expertise in Airbus A330 conversions, and potentially other members of the Airbus family in future. This adds to STE’s industry-leading range of P2F capabilities, on top of its successful MD-11, B757 and B767 P2F programs running currently. EADS EFW will also serve as ST Aerospace’s European MRO center, which fills the only major gap in ST Aerospace’s global MRO footprint. While the investment is not likely to yield returns in the short term, STE’s strong balance sheet allows it the luxury to wait for associate profits to come in when the project is commercialised. EADS EFW has to date converted more than 170 freighters for 39 global customers. Its other projects include A300-600P2F and A310P2F. No change to our earnings estimates for FY12/13F. Maintain BUY with TP S$3.40.

A boost to P2F conversion pipeline

A330 P2F programme on track. ST Engineering announced the finalisation of agreements with Airbus and its parent EADS to collaborate on the A330 Passenger-to-Freighter (P2F) conversion project. The initial agreement had been announced during the Singapore Airshow earlier in February. Under the final agreement, ST Engineering will invest about Euro 110.5m (S$186.6m) for a 35% effective stake in EADS EFW, the P2F conversion arm of EADS. EADS will hold the remaining 65% and will also have a call option over STE’s 35% stake during the engineering development phase of the A330P2F programme. The call option will expire when the engineering work is successfully delivered to EADS EFW. The engineering phase is expected to commence by end-2012.

ST Aerospace will be the engineering lead. ST Aerospace, with its engineering design experience, will be the lead during the engineering and development phase, while EADS will be the lead in terms of actual modifications and marketing. Most of the conversion works will be done at EADS EFW’s facility in Dresden, Germany, with the remainder coming to a dedicated ST Aerospace facility. The first converted aircraft is expected to come into service by 2016, with airlines like Qatar Airways already showing an interest in the programme. The larger A330-300P2F will be targeted at cargo integrators, while the A330-200P2F will be optimised for higher-density freight and longer-range performance.

Expands capabilities, potentially boosts associate profits. If this programme is successful, ST Aerospace will be the first independent MRO to have expertise in Airbus A330 conversions, and potentially other members of the Airbus family in future. This adds to STE’s industry-leading range of P2F capabilities, on top of its successful MD-11, B757 and B767 P2F programs running currently. EADS EFW will also serve as ST Aerospace’s European MRO center, which fills the only major gap in ST Aerospace’s global MRO footprint. While the investment is not likely to yield returns in the short term, STE’s strong balance sheet allows it the luxury to wait for associate profits to come in when the project is commercialised. EADS EFW has to date converted more than 170 freighters for 39 global customers. Its other projects include A300-600P2F and A310P2F. No change to our earnings estimates for FY12/13F. Maintain BUY with TP S$3.40.