ST Engg shares unhit by bid to end deal

LDA notice to end $179m contract referred to lawyers

THE market yesterday shrugged off news that Louis Dreyfus Armateurs (LDA) has given notice to terminate a $179 million contract with the marine arm of Singapore Technologies Engineering (ST Engg).

ST Engg shares hit an intra-day high of $3.14 before closing at $3.13, one cent up from Friday’s closing.

On Saturday, ST Engg announced that ST Marine had received a notice of termination from LDA dated March 17 relating to a shipping contract for a roll-on/roll-off passenger ferry (Ropax).

The Ropax contract – which was inked in July 2007 – was for a price of about $179 million (inclusive of variable options).

According to ST Engg, in the notice served by LDA, it was ‘alleged that there is a delay in the delivery of the Ropax vessel’.

‘They further allege that even if the vessel is tendered for delivery there will be deficiency in the deadweight capacity of the Ropax vessel,’ said ST Engg.

The notice states that LDA is ‘fully prepared to continue to fulfil its obligations under the contract’ in the event that it is not entitled to terminate the contract. However, it added that LDA ‘will become entitled in due course to terminate the contract by reason of deficiency in the deadweight capacity’.

If the notice is valid, ST Marine will be required to refund milestone payments amounting to $129 million plus interest. LDA may also pursue claims in damages.

ST Marine has referred the matter to its legal advisers, ST Engg said, adding: ‘If liable for damages, ST Marine’s position is that under the terms of the contract, its total liabilities for damages are capped at 10 per cent of the contract price.’

ST Engg said that ‘the termination of the contract is not expected to have any material impact on the consolidated net tangible assets per share and earnings per share of ST Engineering for the current financial year’.

RBS analyst Gina Kim said in a research report: ‘Although the company is saying that they expect no material impact on the earnings per share, we believe the negative impact on sentiment may be significant.’

The investment house said that the accumulated milestone plus damages claims can amount to $150 million – which is equivalent to 24 per cent of estimated pre-tax profits in 2011. A UBS estimate put a ‘high’ estimate of the potential charges at 5.5 per cent of estimated net profit for 2011.

However, RBS and UBS have maintained their ‘buy’ and ‘neutral’ ratings respectively. ‘We believe that ST Engg’s dividend payout of 90 per cent is secure despite this turn of events,’ said UBS analyst Cheryl Lee.

RBS added that ‘the relatively good news is that the contract termination value is worth only 1.3 per cent of orderbook and 1.6 per cent of market cap’.

When contacted by BT, ST Engg spokeswoman Sharolyn Choy said she was unable to comment on the lawsuit as it was being reviewed by ST Marine’s lawyers, but confirmed that the lawsuit was a first for ST Marine.

Warthog may stand ST Engg in good stead

SINGAPORE Technologies Engineering (STE) on Tuesday reported an 11 per cent rise in full-year net profit to $491 million, beating analysts' consensus estimates. What it may be proudest of at the moment, though, is not told in those numbers but in the story of a military vehicle named after a wild African pig.

The Warthog, a heavily-armoured amphibious vehicle made by the group's land systems arm ST Kinetics, has now been successfully deployed by the British Army in Afghanistan – if news reports coming out of the UK are anything to go by.

The significance of this requires some background. In December 2008, the UK's Ministry of Defence placed a $330 million order for over 100 Warthogs. This was in response to an urgent operational requirement for its troops in Afghanistan. The Vikings these vehicles were to replace had proven to be vulnerable to roadside bomb attacks in the harsh Afghanistan terrain, costing lives.

Though a contract win of $330 million is relatively small for a large conglomerate like STE, this particular one was something to cheer about, for more than the dollars and cents.

First, any deal at all during that period – the worst of the financial crisis – would have been welcomed, and the nature of this contract underlined STE's distinctive quality as a defence contractor. Defence spending tends to be more resilient than commercial expenditure in times of economic downturn.

STE's order book now stands at $11.5 billion, of which analysts say about $4.7 billion was secured last year. Of this, a CIMB report estimates that about 70 per cent is commercial and the rest, defence-related.

Second, and more salient perhaps, was what it signified: that this homegrown defence and engineering group is now capable of meeting the requirements of a premier armed force, and one involved in combat operations.

Observers said then that the UK win also soothed some of STE's disappointment from a failed bid years earlier. In 2000, the group bid for a US$4 billion contract to supply its Bionix Infantry Fighting Vehicle to the US Army, but lost. Competing against the world's bigger defence contracting players to secure the UK order eight years on was thus a triumph. It boosted STE's confidence as one with land system capabilities good enough for premier armed forces and undoubtedly enhanced its reputation in defence circles too.

The big question then was: could the Warthog deliver? With impressive on-paper specifications, the vehicle was a modified version of the Bronco All Terrain Tracked Carrier (ATTC), used by the Singapore Armed Forces since 2001 in peacetime service. It was clear to market observers and military watchers alike, though, that the proof would be in successful deployment.

That proof is now emerging, it seems, in various anecdotal news reports from the UK, though STE itself seems hesitant to blow its trumpet due to military sensitivities.

Local UK paper Dorset Echo reported last week that the first of the Warthogs arrived in Afghanistan last September, with final batches due to be sent over next month. It quoted an officer conducting trials in a UK camp as saying that not one had been destroyed to date. Another report from a local paper in Kent spoke of a Warthog commander who survived an explosion and is now hoping to marry his fiancee in August.

A third community paper in Hertfordshire, whose report was picked up by Singapore media last month, told the story of a British soldier whose Warthog ran over a booby trap of explosives; he survived, crediting his survival to STE's Warthog.

If the deployment continues to yield success stories like these, the value of reputation built up could far exceed the contract's dollar value and open doors to fresh contracts from the UK or other major armies in the longer term.

Going back to the numbers, analysts said this week that the 50 per cent jump in the automotive business that drove STE's land system arm's growth last year was possibly due to the delivery of the Warthogs. Most maintained 'buy' calls on the group, with at least one analyst from CIMB believing that its order book could exceed $12 billion, with upside surprise from defence contracts.

ST Engg’s US shipyard wins $185m contract

ST Engineering’s shipyard in the United States – VT Halter Marine – has been awarded a shipbuilding contract worth about $185 million by Honolulu-based Pasha Hawaii to build a roll-on/roll-off car truck carrier.

On top of that, the shipyard also signed an option agreement to construct a second vessel with some scope variation for a base price of about $175 million.

Work on the car truck carrier that was ordered will start immediately and the ship is expected to be delivered in the second half of 2013. The ship will ply the Hawaii and US West Coast trade as a weekly service.

This is the second such carrier built by VT Halter Marine for Pasha Hawaii.

‘Building a second ship has always been part of our organisation’s plan. The level of enthusiasm and customer support we received when we deployed our first vessel was well beyond our expectations,’ said George Pasha IV, the chief executive officer of Pasha Hawaii.

‘Our second vessel will both better serve the Hawaii/mainland market and also provide increased frequency and superior reliability. A weekly sailing will also allow us to present even more tailored transportation solutions to our clients.’

The contract for the first vessel, the MV Jean Anne, was awarded to the yard in 2003 and entered service in March 2005. It was designated ‘Ship of the Year’ by American Ship Review in her first year of service.

‘This contract is an extremely important one for our US operations as it reflects VT Halter Marine’s strong credibility and track record among its customers,’ said Ng Sing Chan, president of ST Marine, the marine arm of ST Engineering. The contract is not expected to have any material impact on the per-share consolidated net tangible assets and earnings of ST Engineering for the current financial year.

Event

While ST Engineering’s (STE) headline FY10 earnings of $491m were above our forecasts, this was actually slightly below our core expectations, as STE derived a gain through a change in its depreciation policy. Nevertheless, earnings were generally resilient. STE declared a final and special dividend totaling 11.55cts for a full‐year payout of 90% of earnings. FY11F PER stands at 17.1x, which is fairly valued in our opinion. We maintain our target price of $3.15 and HOLD recommendation.

Our View

• STE reviewed its depreciation policy for its property, plant and equipment during the quarter. Based on the recommendation of independent consultants, it broadly extended the useful life of its operating assets and buildings. This move effectively reduced FY10 depreciation by $39.5m.

• Combined with the interim dividend of 3cts, FY10’s full‐year dividend per share was 14.55cts. This amounts to a 90% payout ratio. Although we were optimistic that STE would resume its 100% payout, management has maintained this more prudent ratio as a buffer against future potential foreign exchange translation losses, which eroded FY10 earnings by around $11m.

• Management sees better PBT for all business segments in FY11. However, we are optimistic that the aerospace division may see an even stronger recovery, trickling down from improving operations in the US and global aviation market. STE’s total orderbook currently stands at $11.5b, versus $10.3b at end‐2009. It expects to convert about $3.7b of this in FY11.

Action & Recommendation

We raise our FY11 and FY12 forecasts by 4% and 6%, respectively, solely due to the change in its depreciation policy. Despite our HOLD rating, forward dividend yield of 5.3% is still attractive, and assumes a continuation of the 90% payout ratio.