Back on the growth track

• Recent MRO contract wins in US point to aviation market recovery, as well as growing 3rd party
outsourcing
• Expect defence and infrastructure contract wins on the back of sustained government spending
• War chest of S$1.6bn points to potential acquisitions; 100% dividend payout likely again
• Maintain BUY, TP revised up to S$3.80

MRO outsourcing set to recover in the US. In Dec’09, STE announced a couple of significant MRO contract wins in the US worth about US$230m (including options), after a long dry spell of US-based contracts in the early part of FY09. We believe this could be the start of a recovery in the US aviation market and we could see more airlines willing to outsource their non-core functions to 3rd party MROs like STE. The ongoing recovery in the air cargo market should also fuel the demand for Passenger-to-Freighter (“PTF”) conversions, where STE has an established presence.

Government contracts will underpin revenue growth. Even after 2009’s impressive stimulus package, the Singapore government has indicated that spending will be stepped up in the 2010 budget – due to be announced just a month from now. STE is a key beneficiary of Government spending on defence, transport and infrastructure and we expect strong order flows to support revenue growth in 2010-11.

Maintain BUY, PE premium to STI not normalised yet. In line with the expected recovery, we revise up our EPS estimates slightly by 1-4% over FY09-11 and raise our TP to S$3.80 – pegged to 23x FY10 earnings. We expect STE to sustain its 100% dividend payout when it announces FY09 results next month, translating to a yield of 5.0% for FY10 and 5.4% in FY11. With over S$1.6b in gross cash following the US$500m bond issue in 2H-FY09, acquisitions are on the cards as well, which will spur its growth to a higher platform.

ST Engg unit wins 33m yuan waste transfer station deal

THE ST Engineering (ST Engg) group has won a tender worth about 33 million yuan (S$6.5 million) in Wuhan, China, for the designing, building and delivery of a waste transfer station in Donghu Newtech Zone.

The project commences immediately and is expected to be completed by the third quarter of next year. The contract was awarded to ST Environmental Services & Technologies Co Ltd (STE&T), a wholly owned subsidiary of STSE Engineering Services Pte Ltd (STSE).

Since its incorporation in July last year, STE&T which is located in Shanghai’s new Pudong area, has bagged contracts worth about $12 million in China, including this latest win. It seeks to tap into China’s growing demand for eco services and technology.

STSE, which specialises in providing turnkey environmental engineering solutions such as waste transfer technology and landfill management, is a wholly owned subsidiary of ST Marine, the marine arm of ST Engg.

Separately, ST Engg announced that its US company, Vision Technologies Kinetics Inc (VTK), has acquired an additional 10 per cent equity stake in US-based MAK Technologies Inc from one of the individual shareholders, John Morrison, who has left the management team of MAK.

The purchase consideration was US$215,297 and, with this purchase, MAK becomes a 90 per cent owned subsidiary of ST Engg. The remaining 10 per cent is owned by Warren Katz, the chief executive of MAK.

VTK is a subsidiary of Vision Technologies Systems Inc, the US headquarters of ST Engg.

MAK is a world leader in simulation software that links, simulates and visualises the virtual worlds in a networked synthetic environment. The company builds commercial off-the-shelf simulation tools and toolkits that are used in developing trainers and simulators, from sophisticated networked mission training simulators to desktop training simulations, according to ST Engg.

ST Engg secures US$87m contract from US Navy

ST Engineering’s US shipyard continues to reel in US defence contracts, announcing yesterday a US$87 million contract to build an enhanced version of a T-AGS 60 Class oceanographic survey ship for the US Navy.
The contract was awarded to ST Marine’s VT Halter Marine. ST Marine is the marine arm of ST Engineering.

Construction of the 107.6-metre new ship, T-AGS 66, will begin at Halter Moss Point in the first half of next year, with delivery scheduled in 2013.

The dynamic positioning-equipped vessel will have various enhancements of its equipment and electronics systems as well as a moonpool for through-hull launch and retrieval of scientific research equipment.

T-AGS 60 Class ships are designed and constructed to provide multi-purpose oceanographic capabilities for the Oceanographer of the Navy.

Typical missions of the T-AGS 60 Class ships may include: oceanographic sampling and data collection of surface, midwater and ocean floor parameters; the launching, recovering, and towing of scientific packages both tethered and autonomous including the handling, monitoring, and servicing of remotely operated vehicles; shipboard oceanographic data processing and sample analysis; and precise navigation, track line manoeuvring, and station keeping to support deep ocean and coastal surveys.

VT Halter Marine is the leading designer and builder of specialised oceanographic ships for the US Navy and has built the previous six ships of the T-AGS 60 Class.

‘VT Halter Marine is pleased to be given the opportunity to continue our long standing partnership with the US Navy and this contract is a testament to our track record of designing and constructing quality T-AGS oceanographic vessels for the US Navy,’ said ST Marine president Chang Cheow Teck.

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.

ST Engg unit wins contract from major US airline

ST Aerospace, the aerospace arm of ST Engineering, has won a contract worth up to US$170 million to provide airframe maintenance services for a major US airline.

The deal includes a US$90 million contract to undertake C- checks and heavy maintenance visits (HMVs) on a fleet of Airbus A320 and Boeing 767 aircraft over three years, with an option to extend for two more years.

Including the option, the total contract value is about US$170 million.

The name of the client was not disclosed, at the request of the airline.

This is ST Aero’s second major contract from a US client in recent months.

In November, it clinched a multi-million-dollar deal to install a new onboard automatic fire-suppression system (FSS) in planes operated by global logistics giant FedEx Corp.

The work will be carried out at ST Aero’s facility in Mobile, Alabama, from the first quarter of 2010.

Commenting on the latest deal, ST Aero president Tay Kok Khiang said the contract affirms the company’s ability to bring value to airlines globally.

‘It extends our position as a preferred supplier of maintenance, repair and overhaul (MRO), and freighter conversion services to airlines large and small,’ he said.

ST Aerospace, which accounts for about half the income of its parent ST Engineering, is the world’s largest independent MRO operator, with a network with facilities in the Americas, Asia-Pacific and Europe.

With about 7,000 employees and technical specialists worldwide, it offers a spectrum of services that include airframe, engine and component maintenance, repair and overhaul; engineering design and technical services; and aviation materials and management services.

The latest contract brings the total value of new projects clinched by ST Aero this year to US$220 million.

Earnings recovery priced in

• Results in line, maintain Underperform. 3Q09 net profit of S$120m (+8% yoy) was in line with our expectation and consensus. 9M09 net profit of S$314m (-15% yoy) forms 70% of our FY09 forecast. We raise our target price from S$2.78 to S$3.09, still based on blended valuations as a result of our earnings upgrade and lower WACC assumption. However, we maintain Underperform as we see limited catalysts to justify premium valuations (18x CY10 P/E) against a modest 3-year earnings CAGR of 4%.

• 3Q09 revenue dipped 2.2% yoy to S$1.3bn with weaker-than-expected revenue from Land Systems because of lower-than-expected project milestone completion, offset by stronger shipbuilding recognition for Marine. Qoq, revenue was down 4% from weaker sales in Electronics, offset by a surge in Marine.

• Aerospace margins improved but still far from historical levels. 3Q09 PBT margins for Aerospace improved 2.7% pts qoq to 14.9% but fell short of our expected 16%. 9M09 PBT margins of 12% were still much lower than their historical average of 20% due to a steep learning curve for the PTF conversion programme. While management sees a potential pick up in the aviation sector from 2010 as airlines resurrect their mothballed aircrafts, we see limited upside for FY10 Aerospace earnings as we have already assumed 20% growth in PBT from a stronger MRO baseload and higher margins.

• Marine stronger than expected. 3Q09 PBT of S$25m (+18% yoy) was above our expectations from a favourable sales mix due to higher shipbuilding at VT Halter Marine US. Shipbuilding margins also improved to 6% (from 3% in 3Q08).

• Earnings estimates raised by 2% for FY10-11 but lowered by 0.3% for FY09, to incorporate: 1) stronger revenue but lower margins for Aerospace; 2) higher margins for Land Systems and Marine; and 3) stronger revenue for Electronics.

• Strong order book. Order book was S$10.3bn, of which S$970m is expected to be recognised in 4Q09. Order-win momentum has accelerated with S$858m new orders secured in Oct 09.

• Earnings recovery priced in. STE is trading at 18x CY10 P/E, slightly above its 5-year average of 17x. We believe current valuations have priced in modest earnings growth (8-12%) expected for FY10 and FY11.