STEng – DB

Successes in military, new fees from Boeing a positive

Successes in military; about S$1.2bn unannounced orders won in 1Q09
STE has seen strong order inflows from its military business and we expect this strength to continue. Sensitive in nature, military orders by the Singapore Armed Forces are often not disclosed but the difference between FY08 and 1Q09 order books (considering 1Q09 recognized total) suggests new orders worth c. S$1.2bn were won in 1Q09, the bulk of which we think are liekly military related. Maintain Buy on what we see as attractive valuation.

Capable, well-regarded military products
STE manufactures products that are well regarded as indicated by the successful UK Bronco sales, continued orders for its 40mm ammunition, and the group previously being the front-runner for potential Indian howitzer order (now put on hold pending an investigation of a retired ordnance official by the Indian authorities). According to STE, its participation followed India’s processes.

Boeing’s new fees on unlicensed PTF players a positive
Effective on or after 15 April 2009, for operators of aircraft converted by non- Boeing licensed converters, a fee of US$150-250k/year/plane will be charged by Boeing. ST Aerospace, being a Boeing licensed partner, will fall under a special category with lower fees paid by operators. This move is positive in our view as it effectively raises the price of PTF work done by non-licensed players and may lead to future potential business flowing to licensed parties such as ST Aero.

Maintain Buy; record orders, net cash, high ROE/dividends; risks
STE is sitting on a record order book of about S$11bn (as at 1Q09), providing healthy long-term visibility. The group is in a net cash position which places it strongly for any potential M&A activities. Our DDM-based target price of S$3.00 is based on a 7.4% cost of equity, (2.6% RFR and 4.8% ERP). Downside risks relate to project execution, greater-than-expected US$ depreciation, and worse-than expected aircraft grounding.

STEng – BT

ST Electronics wins $100m SAF contract

Award involves supply of Advanced Combat Man System

SINGAPORE Technologies Engineering (ST Engg) has been awarded a contract worth over $100 million to supply advanced military technology to the Singapore Armed Forces (SAF).

The award is not expected to have any material impact on the consolidated net tangible assets and earnings per share of the group for the current financial year, ST Engg said yesterday.

The project, awarded to its electronics arm ST Electronics, is expected to be completed by 2012.

The contract is to provide an Advanced Combat Man System (ACMS) to the SAF.

The ACMS is a 3rd Generation Networked Warrior system fully equipped with advanced C4I (Command, Control, Communications, Computers and Intelligence) and network capabilities.

The ACMS is a joint development effort that started in 1998 among the Defence Science and Technology Agency, the Singapore Armed Forces (SAF) and ST Electronics with the support of Singapore Technologies Kinetics.

‘With our strong electronics systems expertise, ST Electronics is committed to delivering solutions that aim to enhance the fighting effectiveness and capabilities of our soldiers,’ said Seah Moon Ming, deputy chief executive of ST Engineering and president of ST Electronics.

ST Engineering’s net profit for the first quarter ended March 31 fell 30.4 per cent to $85.2 million, from $122.5 million a year earlier largely due to its key aerospace unit’s pre-tax profit being halved to $39.8 million as freighter conversion re-deliveries dried up and sales fell.

CEO Tan Pheng Hock said then that the company’s order book was at an all-time high of $11.03 billion and that the company was holding $1.38 billion in cash and cash equivalents.

While aerospace earnings have weakened, defence orders have continued strongly.

ST Engineering sold $1.4 billion of weapons to foreign countries in 2008, including a landmark $330 million deal to supply armoured vehicles to the United Kingdom.

Earlier last month, it secured a $21 million contract to supply 40mm ammunition, again to the UK ministry of defence. Last year, it won two contracts worth $120 million to supply 40mm ammunition to the same customer.

STEng – BT

ST Aero will be at the top when recovery comes: chief

Company’s growth will come from existing businesses and acquisitions

ALTHOUGH the global airline industry is struggling through severe turbulence, established aviation engineering players with geographical spread and technological capabilities will survive the downturn and emerge stronger after an industry consolidation.

And Tay Kok Khiang, the president of ST Aerospace, the aviation unit of Singapore Technologies Industries, sees his company emerging as one of the winners when the dust of the battle settles.

Despite the numerous short-term global shocks, global airline traffic has grown continually on a long-term basis, he said.

‘There has been a 36 per cent rise in air travel since the events of 9/11. Over a 30-year period, growth has been steady, though interrupted every 8-10 years. Global MRO (maintenance, repair and overhaul) spending is expected to grow from US$45.1 billion last year, to US$56 billion by 2013, and US$68.6 billion in 2018.’

And even as airlines park some 800 older planes in a bid to slash capacity, the global fleet grew by 5.6 per cent last year. This year growth will be zero – with the global fleet number stabilising at 19,000 – as retirements are matched by new deliveries.

ST Aero – which is the world’s largest airframe maintenance and third party airframe maintenance company, surpassing competitors Lufthansa Tecknik, Hong Kong’s HAECO and AirFrance-KLM groups – has six major global bases. Besides its two Singapore facilities – Sasco and STA Engineering – its MRO bases include ST Mobile Aerospace in Alabama, San Antonio Aerospace in Texas, Panama Aerospace Engineering and Shanghai Technologies Aerospace (Starco).

The company, which accounts for almost half of listed ST Engineering’s income, is also one of the world’s leading passenger-to-freighter (PTF) conversion outfits in the world.

It is Boeing’s only approved PTF conversion centre for B767-300, MD11 and B757-200 aircraft, and recently clinched a new 10-year US$136 million deal with Boeing for the B767-300 fleet PTF. It also has a Supplement Type Certification for B757 conversion, marking its capabilities as a designer and manufacturer of airframes for that plane.

According to Mr Tay, the company has enough PTF work to keep it busy for the next five years.

‘We have 17 aircraft and 10 options for the B767 conversions, which will take four years to complete. For the 757, we just got an order for 87 aircraft from FedEx, which is replacing its less fuel-efficient 727s. We are rushing to process this as fast as we can.’

The company is also the global leader in engine repair and maintenance. It recently inked various deals with GE Aviation and CFM International to provide MRO, on-wing support, and total aircraft support for the CFM and GEnx engines. Its portfolio includes some 450 engines under total aviation support, and 600 aircraft under component total support.

And its clients include nine of the 13 biggest airlines in the world: Lufthansa, FedEx, JAL, ANA, Delta, Northwest, Qantas, Continental and US Airways. Meanwhile, it has also been picking up discount and low-cost carrier business, including fast growing players like AirAsia, Lion Air, Jetstar Asia and Cebu Pacific.

But ST Aero also faces some real challenges.

Capacity and cost cutbacks by airlines will impact its ‘nose-to-tail’ production. There is also the danger of defaults if airline customers hit the financial skids.

Parent ST Engineering’s net profit for the first quarter ended March 31, 2009, fell 30.4 per cent to $85.2 million, from $122.5 million a year earlier largely due to its key aerospace unit’s pre-tax profit being halved to $39.8 million as freighter conversion re-deliveries dried up and sales fell.

The biggest potential challenge could be competition from OEMs (aircraft and engine makers) moving downstream into MRO services. But Mr Tay does not see this as a sustainable trend.

‘Five years ago, when OEM’s sales fell, some started moving downstream to boost their toplines. But under the current circumstances, most are rationalising their operations and concentrating on margins. What OEMs are doing now is establishing strong partnership with strong global MRO players.’

Indeed, think tanks like Aerostrategy note that established independent players such as ST Aero have become increasingly important partners for OEMs and airlines which are outsourcing MRO jobs to reign in costs. Studies also project a global consolidation in the MRO segment, with bigger players like ST Aero and HAECO buying up smaller independent players.

Mr Tay reckons ST Aero’s growth will come from both existing businesses and acquisitions.

‘We will see organic growth at our existing facilities, but will acquire new capacity if it makes sense. We have $1.3 billion in cash at the group level, negligible gearing and are triple-A rated. So we have lots of capacity for leveraging. Cash is not a concern.’

The issue, rather, is finding a right target, he added. And ST Aero is currently looking for its seventh global base.

Historically, the company has enjoyed annual growth of about 8 per cent. But growth alone is not enough, said Mr Tay.

‘It has to be strategic growth which delivers profitability. It has to enhance our competitive position.’

STEng – CIMB

Valuations still above previous crisis

• Below expectations. 1Q09 profit of S$85.2m (-30% yoy) forms 19% of our FY09 estimate and 18% of consensus. The shortfall was mainly due to weaker-thanexpected performances from Aerospace and Electronics. Poor results provide further justification for our negative view.

• Aerospace dragged down by poor sales mix and one-off financial costs. Aerospace PBT of S$39.8m (-52% yoy) was 30% below our expectation mainly due to: 1) no MD11 freighter conversion redeliveries in 1Q09 which fetch better margins, 2) one-off financial costs of S$6.5m to unwind an interest-rate swap in the CERO business; and 3) no investment income from the EMS business. PBT margins shrank yoy and qoq to 8.7%. Management guided for comparable turnover but lower PBT for 1H09 vs. 1H08. We believe margins for Aerospace could remain weak due to a challenging aviation outlook and losses from PTF conversion projects in 1H09.

• Electronics: weaker-than-expected margins. While Electronics turnover of S$338m was above our expected S$293m, PBT was S$21.7m was below our expected S$26m due to higher operating expenses. PBT margin dropped from 8.2% in 1Q08 to 6.4% in 1Q09. However, we believe the division will catch up from 2Q09, with the help of stronger project milestone recognition for the LTA’s Circle Line, Taiwan MRT projects, communication products as well as software systems. This is in line with management’s earlier guidance of better PBT for FY09.

• Outlook for FY09. Management expects overall FY09 turnover and PBT to be comparable to FY08. Order book grew 4% qoq to S$11bn. Our earnings estimates are intact as we expect a pick-up in 2H09.

• Maintain Underperform and target price of S$2.38, still based on blended valuations. Current valuation of 16x CY10 P/E is still above previous crisis valuations of 13-14x. Widely perceived as a defensive stock, the stock has started to lag recently when the market surged. We believe that the poor results adds a new catalyst for further underperformance, especially since this is one of the most widely owned stock in institutional investor’s Singapore portfolio. We continue to see limited catalysts in the near term.