Contract wins till date

• Total value of announced contracts till date had surpassed that of entire FY2009. Contract value announced till date stands at S$2.27bn.

• ST Aerospace’s Maintenance-By-the-Hour (MBH™) contracts will benefit from increased utilization by its airline customers. Hence, the capacity additions by global airlines and freighters are reflective of increases to Aerospace revenue in 6 to 12months. Being the largest revenue and profit contributor to STE, a rebound for the global aerospace industry is positive for the group.

• We estimate that the MBH™ contracts won by ST Aerospace from Jet Airways, Spring Airlines & T’Way Air in 2010 will add approximately S$130mn to the yearly sales of its commercial aircraft business.

• Under the current low interest rate environment, we believe that STE offers healthy earnings yield at the current price. We expect a 12M-Fwd earnings yield of 5%, which is a 3% premium over 10yr Bond Yield on Singapore Government Securities of approximately 2% (above the 5yr average earnings yield premium of 2.48%). Hence, we maintain our BUY call with a revised target price of S$3.69 based on our FCFE-model (COE: 8.3%, Terminal G= 3.5%).

Continuing to perform

Continuing to replenish its orderbook. STE Engineering (STE) has continued to perform according to our expectations. Since its 2Q10 results, we note that the group has been replenishing its orderbook via new contracts. Specifically, its electronics arm, ST Electronics, had been awarded a contract worth ~S$10.9m to provide SMART vehicle and asset tracking devices for the recovery of stolen vehicles and goods. More recently, it also won a contract worth ~S$29m to supply Automatic Meter Reading (AMR) radio transceivers for Arad Technologies’ AMR solutions. We see these developments positively as these clearly illustrate STE’s strong market position and its ability to deliver reliable and innovative solutions.

May gain from passenger and freight capacity additions. In the aerospace segment, we believe STE may potentially benefit from the return of capacity to the passenger and freight markets. According to the International Air Transport Association (IATA), passenger aircraft orders have surged at recent airshows and aircrafts have been taken from storage at a rate of 195 in 2Q and a further 84 in Jul. While few details were given about the capacity addition in the air freight market, we note that there has also been an additional 11.9% of capacity brought back in Jul (7.7% YTD). Being the world’s largest aircraft MRO service provider, we thus see potential for STE to gain from the return of passenger and freight capacity into the market, especially those coming out of storage.

Higher turnover and PBT expected in 2H10. As a note, STE had guided during its 2Q10 results that its sales and profit before tax (PBT) in 2H10 are likely to fare better than 1H10, lifted by positive contribution from its Electronics, Aerospace and Marine segments. Only the Land Systems segment is expected to post lower PBT in 2H10.

Upgrade to BUY. While STE cautioned that the aviation MRO demand is still lagging and may only see a recovery in 2H11, we believe that the group may get a boost from recent positive news and an earlier-than-expected recovery in the MRO market. As such, we raise our FY10-11 forecasts by 0.4-0.8% to factor in our more optimistic view. With just over a quarter to year end, we also roll our valuation to FY11. At 21x FY11F EPS, our fair value is in turn raised to S$3.66 (S$3.28 on 20x blended FY10/11F EPS previously). We upgrade STE to BUY as we now see a total expected return of 15%.

Towards a strong 2H

• 2Q earnings rose 14% y-o-y in line, no change to our forecasts

• Aerospace division recovery on track, with higher growth expected in 2011

• Maintain BUY with S$3.55 TP; total return of 13% including dividends

Recovery in full swing. The Group reported an expectedly strong set of 2Q results with headline net profit of S$124m, up 14% y-o-y and 34% q-o-q. Revenue was up 8% y-o-y to S$1.5bn, on the back of the continuing recovery in Aerospace division as well as strong auto sales in Land Systems, which helped the division post record revenues in 2Q10 (+ 51% y-o-y). Bronco/ Warthog deliveries to the UK MOD will commence full steam in 2H10 and should be complete by 1H-FY11. Group PBT margin recovered from 8.6% in 1Q10 to 10.4% in 2Q10, driven by improving margins at Aerospace and Electronics divisions.

Aerospace will be the key driver. The aviation recovery will continue to drive Aerospace earnings, though the heavier checks will mostly lag the recovery and will likely kick in towards 2H11, according to management. In the meantime, the S$1bn Jet Airways order win has been followed by other long-term orders from Delta Airlines and Jetstar Group, which will keep the hangars busy. To position itself for the imminent upturn in MRO spending next year, STE has added one hangar in the US and the Xiamen engine facility will come on-stream by end-2010. A new MRO facility at Guangzhou is also expected to be ready by 2012-13.

Maintain BUY, potential yield of ~4.5%. The group ended the quarter with an orderbook of S$11.3bn and gross cash of S$1.7bn, and we remain confident of our FY10-11 forecasts. Our TP is unchanged at S$3.55. A weaker USD will be the key risk, going forward.

Steady growth

• In line; maintain Outperform. 2Q10 net profit of S$124m (+14% yoy) met our expectations and consensus, with 1H10 accounting for 45% of our FY10 forecast. Qoq profits improved in all businesses with Aerospace being the clear leader. Our earnings estimates and target price of S$3.62 are unchanged, still based on blended valuations. We continue to like STE for its: 1) defensive revenue; 2) sustainable high ROEs (30%); and 3) decent dividend yields of about 5%. We see catalysts from more sizeable order wins, M&As and a stronger pick-up in Aerospace.

• Aerospace: more upside in 2011 from MRO pick-up. Aerospace’s 2Q10 PBT of S$64m (+5% yoy, +50% qoq) met our expectations. PBT margins expanded 320bp qoq to 12.8% from stronger work volume. Management attributed this to PTF deliveries and maintenance contracts. There had been no strong pick-up in MRO jobs yet in 1H10 despite the recovery in the global aviation industry as heavy maintenance spending usually lags by 6-12 months, depending on airlines. Therefore, we are likely to see positive spillover in 2H11, providing earnings upside to the division. Aerospace recently secured a heavy maintenance and C-checks contract from Delta Airlines for 75 units of its 757 aircraft. No amount was disclosed but we estimate the contract value at more than US$100m.

• Steady growth in Electronics. PBT of S$35m (+5% yoy, +23% qoq) was spurred by a good sales mix and stronger contributions from iDirect. PBT margins improved 380bp yoy and qoq to 11% from the sale of better-margin products. We expect steady growth from Electronics on the back of the execution of train and transportrelated contracts secured in 1H10.

• Balance sheet remained strong. The group had a net cash position of S$334m. Given its robust balance sheet, we believe it is still on the lookout for acquisitions to power its longer-term growth. Although order book shrank slightly to S$11.3bn in 2Q10 from S$11.8bn in 1Q10, this is still considered high against its historical order books.

ST Engineering’s Q2 net profit rises 14% to $124m

SINGAPORE Technologies Engineering’s net profit rose 14.1 per cent year on year to $124 million in the second quarter, boosted by sharply higher revenue from the sale of land vehicles and equipment.

Its land systems division, which makes specialised military and industrial vehicles, contributed most to the increase in net profit, due to higher project deliveries and vehicle sales.

Its Q2 net profit of $124 million was 33.5 per cent higher than in Q1. For the first half of the year, ST Engineering’s net profit was $216.8 million, up 11.8 per cent year on year.

The group, whose businesses include aircraft repair, shipbuilding, and electronics and weapons manufacturing, had $11.3 billion in outstanding customer orders at end-June. And it expects $2.2 billion of these to be delivered in the current H2.

Part of ST Engineering’s sales come from supplying the Singapore Armed Forces and other military customers. Commercial sales made up 60 per cent, or $913 million, of its Q2 turnover.

Temasek Holdings has a 50.5 per cent stake in the company, comprising a direct holding of 49.6 per cent and smaller stakes held by Temasek-linked companies such as DBS Group and Keppel Corporation.

ST Engineering’s Q2 earnings per share came in at 4.11 cents, up from 3.62 cents a year back and 3.08 cents in Q1 this year. Its share price ended unchanged at $3.26 yesterday, before the earnings announcement.

The group expects 2010 full-year turnover and pre-tax profit to be higher than last year barring unforeseen circumstances, ST Engineering president and chief executive Tan Pheng Hock said in a statement. An interim dividend of three cents a share has been declared, unchanged from the payout a year back.

Turnover at two of ST Engineering’s four main business segments – aerospace and marine – was little changed in Q2 compared with a year ago, at $501 million and $246 million, respectively. A third segment, electronics, reported a 10 per cent drop in turnover to $314 million, due to lower-value project milestone completions during the quarter. But a sharp rise in turnover from the land systems division to $407 million – up 52 per cent from a year ago – boosted the group’s overall turnover 8 per cent year on year to $1.52 billion.

Pre-tax profit rose at all four main business segments in Q2, compared with Q1 and a year ago. The group expects profits to rise in the second half of the year for the aerospace and marine divisions compared with H1. It expects profit to be lower for the land systems segment and little changed for the electronics division.