Promising new convert

ST Engineering will be the first to develop a Passenger-to-Freighter conversion programme for the Airbus 330 aircraft with its recent collaboration. This will strengthen its position in the conversion segment, following its success with the Boeing 757 and 767 aircraft.

Maintain Outperform and target price (blended valuations). At 16x CY13 P/E, the stock is close to its -1 standard deviation of five-year mean. We see catalysts from a stronger-than-expected pick up in MRO contracts.

What Happened

ST Aerospace (ST Aero) has signed agreements with Airbus, EADS and Elbe Flugzeugwerke to collaborate on the A330 Passenger-to-Freighter (P2F) conversion programme. ST Aero will subscribe for new shares in EADS EFW (representing 35% of the enlarged capital)for Euro110.5m(S$186.6m). First re-delivery of the converted P2F is set for 2016. The conversions will be mainly done at EADS EFW’s facility in Dresden, Germany, but some work will be carried out at ST Aero’s facilities.

What We Think

We believe this venture widens ST Aero’s offerings following its success with Boeing’s 757-200, 757-300 and MD-11 P2F.Todate, ST Aero has completed 53 of the 87 units of B757-200 conversions for Fedex (order worth S$470m)and 63 units of MD-11 for Boeing. Its P2F order backlog includes the remaining 34 units from Fedex, 10 units of B767-300,and 15 new B757-200conversionssecured in 1Q12.

The latest collaboration also allows ST Aerospace to utilise EADS EFW’s facility in Germany (eight wide-body hangars) for MRO jobs. This enables STE to re-enter the European market after the closure of its Bournemouth facility in UK in 2006.

According to industry reports, Qatar Airways has expressed interest in gradually converting15-20 of its A330s into freighters. We believe such P2F contracts will materialise after the development phase (by 2014).

What You Should Do

Stay invested. We believe the company’s earnings growth and strong contracts momentum (S$1.8bn YTD) has not been priced in.

ST Engg unit wraps up stake in EcoServices

VT Aerospace acquires 50.1% equity interest

SINGAPORE Technologies Engineering (ST Engineering) has completed the acquisition of a 50.1 per cent stake in US-based engine wash services provider EcoServices LLC, with a restructuring of the original investment terms.

The completion of the investment makes EcoServices a subsidiary of Vision Technologies Aerospace Incorporated (VT Aerospace). VT Aerospace holds the aerospace companies of Vision Technologies Systems Inc (VT Systems), the US headquarters of ST Engineering.

Under the restructured terms, VT Aerospace acquired the 50.1 per cent equity interest for US$20 million, instead of US$33.3 million as announced last December.

But Pratt & Whitney – which retains the remaining 49.9 per cent stake – contributed all the assets of the EcoServices business to EcoServices except the business' intellectual property.

ST Engg unit wraps up stake in EcoServices

VT Aerospace acquires 50.1% equity interest

SINGAPORE Technologies Engineering (ST Engineering) has completed the acquisition of a 50.1 per cent stake in US-based engine wash services provider EcoServices LLC, with a restructuring of the original investment terms.

The completion of the investment makes EcoServices a subsidiary of Vision Technologies Aerospace Incorporated (VT Aerospace). VT Aerospace holds the aerospace companies of Vision Technologies Systems Inc (VT Systems), the US headquarters of ST Engineering.

Under the restructured terms, VT Aerospace acquired the 50.1 per cent equity interest for US$20 million, instead of US$33.3 million as announced last December.

But Pratt & Whitney – which retains the remaining 49.9 per cent stake – contributed all the assets of the EcoServices business to EcoServices except the business' intellectual property.

All engines firing

• Good start with 1Q12 net profit of S$134.4m (+ 21% yo-y) beating our estimates

• Strong order win momentum in FY12 implies record orderbook levels of close to S$13bn

• Healthy operating cash flows secures dividend outlook

• Maintain BUY and S$3.40 TP

Highlights

Good start to the year. STE reported better-than-expected 1Q12 results, with net profit up 21% y-o-y to S$134.4m on the back of flattish revenues. 1Q12 earnings account for close to 24% of our FY12F, higher than the historical range of 19-22%, as 1Q is generally a seasonally slower quarter for STE. However, we prefer to be conservative and our earnings estimates are unchanged for FY12.

Aerospace and Electronics were the key revenue drivers in 1Q12, as Land Systems revenue declined with the completion of the UK Warthog programme in 1H2011. Gross margins improved across all key segments. While the company had to incur S$7.1m additional SG&A expenses for the Singapore Airshow in 1Q12, this was more than offset by associate contribution of about S$10.8m from Experia, the event organizer of the Singapore Airshow. Operating cash flow in 1Q12 was exceptionally strong at S$546m, due to advance payments/ deposits on newly secured contracts.

Our View

Record orderbooks provide healthy earnings visibility. STE has had a string of major contract wins YTD, including an S$880m contract from the Royal Navy of Oman, contract for building 2 AHTS vessels for Swire Pacific, and a PTF conversion order for 15 B757-200s, among others. Total announced new orders exceed S$1.9bn already in FY12, compared to about S$3.2bn order wins announced in full-year FY11. This brings the outstanding orderbook to an estimated record level of ~S$13bn.

Recommendation

Maintain BUY. Given the recent spate of contracts and attempts at revving up some inorganic growth engines, STE’s growth trajectory seems to be on track. STE looks set to make bigger strides in the Electronics and Land Systems sectors, and has recently teamed with US-based Fortune-500 company Science Applications International Corporation (SAIC) to bid for the US Marine Personnel Carrier program in future. Given the healthy earnings visibility, strong balance sheet and attractive dividend yield of over 5.5%, we maintain our BUY call on the stock with an unchanged TP of S$3.40.

Off to a Strong Start

Strong profit growth. ST Engineering (STE) reported a strong set of 1Q2012 results, with Net Profit of SGD 134.4 mil reflecting an increase of 21% YoY. These results were broadly within our FY2012 expectations – we will be maintaining our forecasts and BUY recommendation based on STE’s historical P/E mean of 19x. STE’s growing orderbook, contributed by all four business segments this quarter will continue to provide earnings visibility and resilience amidst the backdrop of global economic uncertainty.

Boosted by healthier margins across the board. Although 1Q2012 revenue came in almost flat YoY, healthier net margins of 8.7% versus 1Q2011 margins of 7.1% boosted profits. Encouragingly, all four business segments posted improved margins, led by ST Marine which benefited from a favourable sales mix.

Strong cashflow. Another highlight of STE’s 1Q2012 financial performance was its strong operating cashflow at SGD 547 mil, which contributed to an improvement of its net cash position to SGD 565 mil from SGD 2.2 mil, and providing support for our forecasted FY2012 DPS of SGD 0.17 (increase of 10% vs FY2011).

Outlook positive. Management forecasts a positive outlook for three of its four business segments. Its Aerospace, Electronics and Marine sectors are expected to record higher PBTs in 1H2012 vs 1H2011. Only its Land Systems segment is expected to show comparable profit.

Solid business fundamentals – Maintain Buy. STE has a solid business model underpinned by defence contracts (40% of 1Q2012 revenue), with earnings visibility continually provided by its growing orderbook. Its business segments continue to show positive macro trends to support growth and provide a basis for earnings resilience. We reiterate our BUY recommendation for STE pegged at 19x FY12 PER, based on its 10-year historical PER mean.