Promising set of results

• Net profit of S$120m(+11% qoq) is in line with expectations
• Strong rebound in aerospace margins q-o-q, as PTF conversions become profitable
• We expect MRO market recovery in FY10
• Maintain BUY; revised TP of S$3.30, attractive dividend yield of 4.8%.

Group PBT up 7% q-o-q. 3Q09 revenue of S$1.35b (down 2% y-o-y, 4% q-o-q) and net profit of S$120m (down 7% yo-y, up 11% q-o-q) were in line, and 9M09 net profit of S$314m equates to 74% of our full year projections. 3Q09 PBT of S$149m, though, was higher, driven by strong performances in the Aerospace and Land Systems segments.

Margin recovery in Aerospace to 3Q08 levels. Aerospace PBT climbed 15% q-o-q, as margins improved further to 15% vs.12% in 2Q09 – on the back of profitable PTF conversions. Land Systems PBT jumped 62% q-o-q on the back of a better product mix.

Order backlog still looking good. Orderbook at the end of 3Q09 stood at S$10.3b, down slightly from the end-2Q number of S$10.7b. About S$0.9b of this will be delivered in 4Q09. However, going by the S$865m of order wins already announced in Oct’09, the orderbook should be more than replenished at the end of 4Q09.

Maintain BUY. Our earnings estimates for FY09 remain unchanged, since 4Q09 may be impacted by a weaker USD. However, given our view that the MRO players could lead the recovery in the air travel industry, and given the better visibility of the profitability of the PTF conversions, we re-look our assumptions for the Aerospace segment and revise up our FY10 and FY11 EPS estimates by 6% and 3%, respectively. Our target price is correspondingly revised to S$3.30, still pegged to 20x FY10 earnings. While STE has outperformed the STI index since our recent upgrade, we believe it still has some way to run, given that it is still trading at valuation premiums much lower than the historical average of 40%.

ST Engg Q3 profit drops 6.7% to $120.3m

It says it continued to get new orders, contracts despite a challenging market

ST Engineering yesterday reported net profit for the third quarter to Sept 30, 2009 fell 6.7 per cent to $120.3 million, from $128.9 million a year ago, largely due to substantially higher taxation and a lower share of results from associates.

Revenue was largely stable, falling 2.2 per cent to $1.35 billion from $1.38 billion in the same quarter last year. But cost of sales fell 4.8 per cent, helping to lift pre-tax earnings 3.3 per cent to $149.1 million.

Fully diluted earnings per share fell to four cents from 4.29 cents.

The company also recorded a 45 per cent increase in other income to $12.9 million, largely due to $9.9 million received in the quarter from the government’s Job Credits scheme.

As at end-September, the company’s cash and cash equivalents and short-term investments totalled $1.64 billion and advance payments from customers stood at $1.37 billion. Net cash from operating activities for the quarter doubled to $197 million from $100.5 million a year ago. This was due to lower income tax paid and favourable working capital movements, the company said.

The company said its land systems and marine sectors recorded higher before-tax profit, offset by profitability at its aerospace division, a major contributor. ST Engineering said this was due to lower turnover partially offset by profit from its ongoing 757 freighter conversion programme.

Quarter on quarter, aerospace profitability was higher by 15 per cent or $9.3 million, while land systems was higher than in Q2 by some 62 per cent, or $10.7 million. Overall, quarter-on-quarter profit before tax rose 7 per cent and commercial sales made up 62 per cent of group turnover.

The group’s order book remained strong at $10.3 billion, with about $970 million due for delivery in the last quarter of 2009.

President and chief executive officer Tan Pheng Hock said: ‘In Q3 2009, the group continued to secure new commercial orders and also won several new contracts from governments around the world despite a challenging market.’

The company said it expected, barring unforeseen circumstances, to achieve comparable turnover and before-tax profit in 2009, compared to 2008. Turnover for its aerospace segment is expected to be stable, but profitability could be lower, the company guided.

ST Engineering gained seven cents or 2.4 per cent to close at $2.95 yesterday, just one cent off its 12-month high of $2.96 reached on Oct 21.

Contract win for VT Miltope

VT Miltope wins US$500m contract

Maintain Underperform; upgrade target price from S$2.38 to S$2.78. ST Engineering’s land system subsidiary, VT Miltope, in the US announced that it has secured a 5-year Indefinite Delivery Indefinite Quantity contract worth US$500m to supply rugged laptops, test equipment and instruments to the US army. We raise our earnings estimates by 1% for FY10-11 to incorporate the contract. Our revised target price is still based on blended valuation as we upgrade our earnings, roll forward to end-CY10 and adopt a higher P/E of 17x (previously 11x on SARS valuation) in view of a recovery of the global economy. However, we continue to see limited catalysts for a re-rating of the stock given a muted outlook for the global aviation sector.

VT Miltope to perform 70% of the US$500m contract. The 5-year contract was awarded by the Test, Measurement and Diagnostic Equipment Product Directorate of the US Army. The US Army has the flexibility to take delivery of the AT Platform Automatic Test Systems Maintenance Support Device – Version 3 (MSD-V3) comprising rugged laptops, test equipment and instruments over five years from 2010 to 2014. Some 70% of the contract will be carried out by VT Miltope and 30% by its subcontractor, Science and Engineering Services Inc. We estimate VT Miltope’s share of the contract at US$350m (S$495m).

Estimated S$100m of annual revenue. Assuming that the programme is evenly rolled out over five years, we estimate S$100m of revenue or S$4m of net profit for the group each year. Our earnings estimates have been upgraded by 1% for FY10-11 accordingly.

Valuation and recommendation

Maintain Underperform. ST Engineering is trading at 17x CY10 and 16x CY11 P/Es, close to its 5-year historical average (17x). Although it offers decent yields of 5-6%, we continue to see limited stock catalysts in the absence of a strong pick-up in the aviation sector in the short term. However, we upgrade our target price from S$2.38 to S$2.78 as we upgrade our earnings, roll forward to end-CY10 and apply a higher P/E
of 17x (previously 11x on SARS valuation) in our blended valuation.

Poised for re-rating

• Wins S$710m 5-yr contract from US Army
• Land Systems will drive revenue growth in FY10, Aerospace expected to recover
• Upgrade to BUY, TP revised up to S$3.10
• FY09 dividend yield of 5% will provide support

Sizeable contract win. ST Engineering’s US-based Land Systems subsidiary, VT Miltope, has won a 5-year US$500m (~S$710m) contract to supply automatic test systems to the US Army. The 5-year Indefinite Delivery Indefinite Quantity (IDIQ) contract will allow the US Army the flexibility to acquire items like rugged laptops, test equipment and instruments, within stated limits.

Land Systems will drive revenue growth. The announcement takes the value of new contract wins announced in 2H09 to more than S$1.1bn, and comes on top of its existing S$10.7bn orderbook as of end-
2Q09. Along with the expected commencement of deliveries of the Bronco All Terrain Carriers to the UK Ministry of Defence from end-2009, this contract will further boost the performance of the Land Systems
sector in FY10 and FY11. The Aerospace segment will be the other key earnings driver in FY10, with margin recovery on track, as PTF conversions turn profitable. We have revised up our FY10 EPS estimates by about 2.6%.

Laggard for too long. The stock has underperformed the STI by 32% since April’09, and current valuation premium to STI Index of less than 10% is much lower than historical average PE premium of 40%. We believe this narrowing is unsustainable – given STE’s superior cash flow generation, defensive earnings base and 100% dividend payout record – and upgrade the stock to BUY at a revised TP of S$3.10 (20x FY10 earnings, compared to STI trading at 15x FY10). Dividend yield is a healthy 5.0% and further catalyst may be in the form of M&A funded by its recent medium term notes issuance.

ST Engg wins US$500m US Army contract

It’ll supply laptops, test equipment and instruments

ST Engineering has won a US$500 million contract to supply rugged laptops, test equipment and instruments to the US Army.

The five-year ‘indefinite delivery indefinite quantity’ contract gives the US Army the flexibility to acquire the items, known as At Platform Automatic Test Systems (APATS) Maintenance Support Device – Version 3 (MSD-V3) system, within stated limits.

ST Engineering’s US subsidiary VT Miltope will supply 70 per cent of the programme, with a subcontractor supplying the remainder.

The MSD-V3 is based on the TSC V3-GM45 rugged convertible laptop computer, the next generation of its TSC-750 computer, the company said.

VS Miltope, which makes the rugged computers, has been supplying its products to the US military for years. Over 20,000 units were deployed with US troops in Iraq earlier this decade. The computers are also supplied to the US Air Force, but the new contract is likely to be the biggest yet.

The militarised laptop is designed and qualified to withstand the harshest tactical environment for computer systems and is being used in forward areas under extreme weather and handling conditions.

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 Engineering has had recent successes in foreign military contracts.

Last year, it secured a breakthrough £pounds;150 million (S$339 million) deal with the British army to supply over 100 armoured vehicles for use in Afghanistan.

Its land systems arm in July won a US$11 million deal to supply asphalt paving equipment to the US Army, the first defence sale for VT LeeBoy, an ST Engineering unit which is a leading manufacturer of commercial-class asphalt pavers.

The company has also secured multiple contracts supplying ammunition to foreign military forces, most recently a £pounds;2.8 million contract to supply 40mm ammunition to the UK Ministry of Defence, which it has done since 2002.

Yesterday, the company’s aerospace arm was awarded a Defence Industry Award of Excellence by the Defence Industry Committee of New Zealand (DICNZ) for its development of a multi-role combination solution for two Boeing 757-200 aircraft for the Royal New Zealand Air Force (RNZAF).

The second of the two converted aircraft was successfully redelivered this year with enhanced capabilities to RNZAF, and both are now operational, the company said.