Cautiously optimistic despite turbulence

Better than expected if certain items were excluded. In the year to Dec 08, ST Engineering’s (STE) net profit came off by 5.9% to S$473.6m on the back of a 5.8% increase in revenue to S$5,344.5m. Full year net profit had fallen short of our estimates at S$514.2m, although we note that it would have came in at S$529m and beaten our expectations should the S$25.9m impairment of investments and the S$29.5m allowance for doubtful debts be excluded.

Still expecting comparable earnings in FY09 despite the current economic turmoil. With its order book at a record S$10.6b (of which S$3.6b would be fulfilled in FY09), management highlighted that its mixture of commercial and government contracts would serve as a good buffer in this current downturn, especially so given that the various countries are implementing their respective stimulus packages to make up for the shortfall in private sector spending.

Furthermore, STE’s extensive geographical reach would also ensure that the risks pertaining to protectionism issues – as the various governments attempt to restrict spending to their own countries – are kept low. Additionally, we also note that STE’s exposure to new markets, which have been less affected by the current downturn, have also been steadily increasing.

Earnings and target price revision. Given the tepid economic outlook, we have reduced our FY09 earnings by 18% to S$465.2m (-1.8% YoY). We have also introduced FY10 earnings, which we estimate to grow 10.9% to S$516.0m. At S$2.06, STE is trading at 13.3x FY09 and 12.0x FY10 P/E, which is at the lower end of the trading band. Assuming that the Group keeps to its 100% payout, dividend yield remains attractive at 7.5 – 8.3% for the next two years. Based on our DDM, we attain a price target of S$2.47 (previously S$2.83), suggesting a 19.8% upside from current levels. The new target price implies a prospective P/E of 15.9x, lower than the 5–yr average of ~20x. Maintain BUY.

ST Engg Q4 profit down 30%

Full-year earnings dip to $473.6m, due to doubful debts, impairment charge

ST Engineering’s net profit for the fourth quarter ended Dec 31 has fallen 30.1 per cent to $102.3 million, from $146.4 million a year earlier.

However, sales rose 3.8 per cent year on year to $1.35 billion, from $1.3 billion in the same quarter last year.

For the full year, ST Engg made a net profit of $473.6 million, down 6 per cent from $503.5 million, even though turnover was up 6 per cent at $5.34 billion from $5.05 billion previously.

Much of the hit was due to an impairment charge of $23 million for quoted securities, while the company also made a net allowance of $32.4 million for doubtful debts.

Full-year diluted earnings per share came to 15.74 cents, down 7 per cent from 16.91 cents for FY2007. The company declared a final dividend of 12.8 cents to take full-year payout to 15.8 cents, or 100 per cent of net profit, as has been the custom.

Chief executive officer Tan Pheng Hock said that ‘definitely, the scale and size of (potential) acquisitions will affect’ future dividend payouts but said that the company, which has a triple-A rating, would prefer to take on debt for any new purchase.

Mr Tan noted that the company still had cash and cash equivalents of $1.05 billion, with net cash from operating activities of $511.4 million.

Meanwhile, the company has withdrawn all its money from fund managers, and so will not likely take any hit if markets head further south. It has also ‘very liquid’ cash parked with associated companies in the Temasek Holdings stable, which can be drawn on within two months, Mr Tan said.

All its business segments reported lower profits for the full year, except for Land Systems. Aerospace was the second-hardest hit, after Marine, with pre-tax profit falling 20 per cent, to $272.1 million.

The aerospace business accounts for about half of group earnings and had been hurt by unfavourable exchange rates, higher depreciation, more doubtful debts following the bankruptcies of two clients in the last quarter, and lower contribution from its component and engine repair/ overhaul business group.

Mr Tan said that the company’s strong order book – $10.6 billion at the end of last year, with $3.63 billion of that due this year – would afford it ‘operating leverage to weather an uncertain 2009’. However, ‘a drastic deterioration in our operating environment would affect our performance.’

Otherwise, the company expects higher sales and comparable pre-tax profits this year compared to last, he said.

Mr Tan also disclosed that ST Engg would save about $20 million from the recently announced one percentage point cut in corporate tax rates and the Jobs Credit scheme and said that there were no plans to lay off staff in Singapore.

ST Engg shed 13 cents or 5.9 per cent to close at $2.06 yesterday, its lowest since late October.

Holding Fort

We upgrade ST Engineering to BUY with a target price of S$2.80. Amidst the worsening global economic outlook, STE has sustained its reputation of being a defensive counter, with a slew of new contract wins in recent months across different segments. In spite of possible slowdowns in its Aerospace and Marine segments, we are positive on the stock given 1) its ability to boost growth through M&A, 2) a relatively secure dividend yield of 7%, 3) record orderbook of
S$10b and 4) cash and cash equivalents of S$1b.

Robust orderbook of S$10b will drive revenues.
Contract wins have been stable across the Group’s subsidiaries in recent months, demonstrating the defensive nature of the Group’s diversified earnings stream. It is also in line with our expectation that public spending in defence, transport, and infrastructure projects will mainly drive revenue growth over the next two years.

US operations may recover faster than expected.
Even though major US airlines have pared capacity in FY08, jet fuel prices have corrected significantly and airline industry losses, going forward, will be lower than previously expected. Hence, the demand for 3rd-party MRO work may recover earlier than projected.

Upgrade to BUY, attractive dividend yield of 7%.
The group is focused on enhancing value for shareholders and STE has been paying out 100% of its earnings as dividends since 2002. As a result, the Group has been able to generate very high ROEs in the range of 30%, while still retaining cash and cash equivalents of approximately S$1b at the end of 3Q08. We believe this strong cash holding will present potential growth upside – in the form of good acquisitions at distressed valuations.

So much riding on ST Engg’s UK deal

IN TROUBLED economic times like these, a S$340 million deal is good news indeed, even for a big conglomerate used to large contracts.

But to Singapore Technologies Engineering (STE), the significance of its latest UK order goes beyond mere dollars and cents.

Two weeks ago, STE announced that it has won a £150 million (S$321 million) contract to supply over 100 Bronco all-terrain tracked carriers (ATTCs) for deployment by the British armed forces in Afghanistan. The contract was awarded to STE’s land systems arm, Singapore Technologies Kinetics (ST Kinetics), by the UK Ministry of Defence (UK MOD).

The new order makes up less than 5 per cent of STE’s outstanding confirmed orderbook. It has, however, highlighted STE’s defensive qualities at a time of a major economic downturn. As analysts have noted, with its strategic aircraft maintenance and repair (MRO) facilities in the US and its home market, STE should see more third-party work as major airlines and low-cost carriers increase outsourcing to improve profitability. As Singapore’s key defence contractor, STE is positioned to benefit from any increase in defence spending by Singapore and/or its allies – with such spending usually more resilient in an economic crisis than commercial expenditure. An orderbook of S$9.5 billion provides earnings visibility, while dividend yields remain attractive at around 7 per cent.

But the UK win also means much more than all that to the home-grown defence and engineering group. To understand this, just flash back to 2000. That year, STE bid for a high-profile US$4 billion contract to supply its Bionix Infantry Fighting Vehicle (IFV) to the US Army. At the time, the Bionix, which had replaced the US-made M113 as the main IFV of the Singapore army, was seen as the best illustration of STE’s land systems capabilities, and the vehicle was also well regarded in defence circles. While STE played down its chances during the bidding process, there were privately held hopes within the group that it may – against the odds – succeed.

In the event, such hopes were dashed when STE lost the bid. The process was not entirely futile. As STE chief Tan Pheng Hock was to recall in a later interview, the group extracted a lot of value out of the bid, if not in dollar terms. STE obtained a profile in the US that it never had before, and the fact that the US army was even evaluating the Bionix was an acknowledgement of the group’s capabilities. And notwithstanding the lost bid, the US became the biggest market for STE across its business segments, accounting for one third of the group’s revenue.

But still, there was no hiding the disappointment. And losing the US army bid confirmed to some – both within and without the group – that it would be always an uphill task for a non-traditional source like STE to win a major contract from the world’s premier armed forces.

It isn’t difficult then to see why the UK order – a response to an Urgent Operational Requirement (UOR) – is seen as a breakthrough deal for the STE. Partly, it will help erase some of the disappointment felt in 2000. More significantly, it has shown that STE is capable of meeting the requirements of a major army, and one that is currently conducting combat operations. The boost this will give to STE’s reputation and confidence in the marketplace cannot be underestimated.

This makes it vital that the order is successfully executed. While the deal has been won, the success of the contract cannot still be taken for granted. Vehicle deliveries will commence in the third quarter next year, with the majority to be delivered in 2010. The Broncos will reach the UK to undergo transformation to become the armoured, all-terrain vehicle Warthog to replace the existing Viking in Afghanistan. The on-paper specifications of the Warthog are impressive. It will be powered by a 7.2-litre engine producing 350 bhp and will be able to move through water – all while carrying up to 14 troops. When not in water, the highly agile, all-terrain vehicle will be able to climb steep gradients, cling to severe side slopes, tackle vertical obstacles and roll across trenches. Four Warthog variants will be built under the contract – troop carrier, ambulance, command, and repair and recovery.

But as all military watchers know too well, the true test will be how the Warthog performs in operational conditions in Afghanistan. While the main Bronco model is already in peace-time service with the Singapore Armed Forces, this will be the series’ (and perhaps STE’s) first major test under combat conditions.

A successful deployment may open the doors to more orders from the UK and possibly from other nations, given the coalition nature of Allied operations in Afghanistan. If the deployment reveals serious failings, it will take away much of the good that came with winning the contract. STE has its work cut out to make sure, as far as it is possible, that the Warthog shines in the field.

ST Engg wins $30m contract

SINGAPORE Technologies Engineering’s marine unit, ST Marine, sealed a $30 million design, construction and outfitting contract to build a 68-metre seismic survey vessel for Swire Pacific subsidiary Swire Pacific Offshore Operations (SPO).

SPO is one of the world’s most established offshore support providers with over 20 new vessels on order for delivery till 2011. It has done extensive planning for this newbuild vessel and will be providing the vessel’s basic design and major equipment, including the seismic survey equipment. The vessel will be in compliance the American Bureau of Shipping classifications, and will also have Ice Class Notation C.

ST Marine has also been slowly building up its expertise and reputation in the speciality vessel market. Just last month, it secured a contract to convert a platform supply vessel to a geotechnical survey vessel and in July, it got another job to build and outfit a diving support vessel.

Construction for the latest contract is expected to start in May and delivery is scheduled for the second half of 2010. The deal is not expected to have any material impact on the consolidated net tangible assets per share and earnings per share of the group for the current financial year.

‘As one of the global leaders in the offshore marine industry, we remain committed to continuously improving the standards in technical excellence and client-oriented services. Marine services in the seismic survey industry, like exploration and development support, is an exciting field in which we have now established a firm footing. Given ST Marine’s sterling reputation, I believe that we have found a reliable partner that is more than able to deliver a top quality product,’ said SPO deputy managing director Brian Townsley.

‘We are very honoured to partner Swire Pacific Offshore to augment its modern offshore fleet. This contract is a significant milestone in ST Marine’s relationship with SPO and we hope to partner SPO further in its dynamic growth. Through this contract, we shall be building our first seismic survey vessel in Singapore, leveraging our experience of having repaired and converted almost 100 seismic survey vessels,’ said ST Marine president Chang Cheow Teck.

ST Engineering shares closed seven cents lower at $2.29 yesterday.