Crisis valuations

• Crisis valuations, negatives priced in. STE’s share price has receded 30% YTD on concerns over a slowdown in the global economy and aviation industry. We believe its current crisis valuations (13x CY09 P/E, below its post-911 valuation of 14x in 2001 and close to its post-SARS valuation of about 13x) have incorporated a weak macro outlook and cost pressures on the aviation industry.

• Breather from declining oil prices. The recent retreat in oil prices below US$100/barrel has started to take some pressure off airlines. IATA has also revised its financial forecast for 2008 to a net loss of US$5.2bn, based on an average oil price of US$113/barrel, short of the US$6.1bn worst-case forecast in June when oil cost US$135/ barrel. Although the weakness should persist into 2009, with forecast net losses of US$4.1bn, the outlook is more sanguine than after 911 (US$11bn loss) and SARS (US$6bn loss).

• Defensive. STE’s earnings growth is expected to be decent at a 3-year EPS CAGR of 9% and ROEs towering above 30%. A strong net cash position should also ensure high payouts (100% typically unless there is a large acquisition) with yields of 7%.

• Upgrade from Neutral to Outperform but target price remains S$3.39, still based on blended valuations (DCF, P/E, dividend yield and DDM). We have left our earnings estimates intact. STE is trading at trough valuations of 13x CY09 EPS or a 30% discount to our target price. Key catalysts could include new acquisitions, sizeable contract wins and a strengthening of the US$.

Margins weakened at Aerospace

Story: 2Q08 net earnings of S$119.9m was disappointing, coming in 2% below 2Q07 numbers due to lower-thanexpected earnings growth in the Aerospace and Land Systems segments. The weaker US$ shaved S$12m from group PBT in 1H08.

Point: The 18% y-o-y dip in Aerospace earnings came on the back of flat revenues as PBT margin slid more than 3 ppts to 15% (historical low) on account of i) the depreciating US dollar, ii) slower than expected ramp up in new facilities (Panama) and iii) higher prototyping costs as the Group worked on conversions of three types of passenger aircraft to freighters. Land Systems profits fell 9% y-o-y as a result of lower margins in the automotive segment and higher losses from associate CityCab. Electronics segment profit was up 13% y-o-y on the back of higher contribution from iDirect, which launched its new products. Marine segment was the
surprise package with earnings growth of 21% despite lower sales, as higher proportion of high-margin ship-repair works led to a 2.5 ppt margin expansion. With recent contracts wins (to build a Diving Support Vessel) and renewals (component supply to Polish Airlines) in place, orderbook stands at S$9.3b, of which about S$2.1m should be recognised in 2H08.

Relevance: We have revised our FY08 and FY09 earnings forecasts downwards by about 6% and 5% respectively. Management guided for flat FY08 earnings vs modest growth previously. We reiterate our concern about the Group’s exposure to the US airline industry – which is in the midst of paring capacity – and to the weak US economy (via Marine and iDirect in addition) to the extent of 28% of Group sales (down from 34% in 1H07). The recent strengthening of the US$, however should provide some respite to earnings, if sustained. As such, we keep our Target Price unchanged at S$2.80, and continue to maintain HOLD on the stock given attractive dividend yield in excess of 6%.

ST Engg Q2 profit falls 2.3% to $119.9m

Aerospace business makes up 51% of group’s net earnings in second quarter

WITH mixed results across its business sectors, Singapore Technologies Engineering (ST Engg) yesterday reported net earnings of $119.9 million for the second quarter ended June 30 – 2.3 per cent down from the corresponding period last year.

Group revenue held its ground at $1.3 billion, a slight 0.2 per cent higher than a year ago.

Hit by a weaker US dollar, lower investment income, higher depreciation, higher passenger-to-freighter prototyping costs and lower associated companies’ contributions, net earnings for the aerospace sector fell 11 per cent to $61.6 million in Q2 2008.

Land systems saw net earnings drop 6 per cent to $20.6 million. Lower contributions from associated company CityCab was one reason for the fall.

In contrast, net earnings for the marine sector rose 17 per cent to $16.2 million in Q2 2008. The electronics sector raked in net earnings of $21.1 million, 6 per cent more year on year.

ST Engg’s earnings per share was 4.01 cents in Q2 2008, 0.15 cents lower than in the year-ago period.

The group declared an interim dividend of three cents per share.

‘Our diversity helps us,’ said ST Engg’s president and CEO Tan Pheng Hock, referring to the group’s customer base and activities across business sectors and geographical regions.

Order book for the group grew by another $100 million in the second quarter to $9.29 billion as at end-June, of which some $2.14 billion would be delivered in H2 2008.

But attention at yesterday’s results briefing was centred on the aerospace business, which made up 51 per cent of the group’s net earnings in Q2 2008.

‘We have tier one customers and . . . (they) are more particular about performance and quality than about prices,’ said ST Aerospace’s president Tan Kok Khiang, when asked about the sector’s margins in today’s environment.

While the business climate may be bleaker, there are acquisition opportunities for ST Engg in areas such as the United States, Europe, China and Vietnam. ‘Valuations are definitely more reasonable,’ said group president and CEO Mr Tan.

But he added: ‘We want to ensure that we buy companies that are not in trouble, companies that are able to add value to us strategically.’

Results for ST Engg were stronger when viewed on a half-year basis. The group turned in net earnings of $242.5 million, up 4.7 per cent from a year ago. Revenue increased by 3.9 per cent to $2.62 billion.

ST Engg expects turnover and profit before tax to be ‘modestly higher’ in H2 2008 compared with the first half. As for FY 2008, profit before tax could be comparable to the previous year’s.

ST Engg shares closed unchanged at $2.80 yesterday.

2QFY08 missed; visibility remains poor

● ST Engineering reported 2Q results on Tuesday evening. The results were weaker than the company’s guidance as well as our expectations which are below consensus estimates.

● Due to lower contributions from Aerospace, overall 2Q operating profit rose only 2% to S$149 mn. The weakness at Aerospace is attributed to a weaker US$, higher prototyping costs and higher depreciation on the back of increased capital expenditure.

● 1H08 turnover and net profit represents 47% and 45%, respectively, of our full year previous projection. Consequently, we have cut our FY08 net earnings forecast by 7% and expect more substantial cuts in consensus numbers. We have also cut our DCF-based target price by 7% to S$3.22 (from S$3.47).

● YTD, the stock has already fallen 25% and underperformed the market by 7%. Also, the dividend yield of 6% should provide some downside support. However, trading at 17x FY08E and 15x FY09E P/E, the stock is still not cheap – especially given the company’s growth profile. We are maintaining a NEUTRAL rating.

ST Marine bags S$127.7m deal to build diving support vessel

SINGAPORE Technologies Marine (ST Marine) has secured a S$127.7 million contract to build and outfit a diving support vessel (DSV) for a foreign customer registered in Singapore.

The marine arm of Singapore Technologies Engineering (ST Engg) will build the 107.1m long, 4,000 dwt DSV, which will have a light ‘Ice Class’ notation, in accordance with rules set by Norwegian ship classifier Det Norske Veritas.

The vessel will be equipped with an electric propulsion system with dynamic positioning capability, and have an accommodation space for 100 persons. It will carry a 140-tonne subsea crane, an 18-men diving saturation system and carry two remotely operated vehicles to support diving operations in the subsea sector.

Construction is slated to begin in January next year and delivery is planned for mid-2010. When completed, the DSV will add to the customer’s fleet to serve its clients in the oil and gas industry.

‘This contract signifies an important milestone for ST Marine’s foray into the offshore deepwater oil and gas exploration and subsea sector,’ said ST Marine president Chang Cheow Teck.

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

Contracts won by ST Marine this year included a US$19.4 million deal to build an anchor handling tug and supply (AHTS) vessel, which has deepwater offshore capabilities as well, for Ezra unit Lewek Shipping. In February, it clinched a S$28 million contract from Norway-based Wavefield-Inseis, which provides marine geophysical services using highly specific vessels and the latest seismic equipment, signalling again ST Marine’s capability as a turnkey provider of speciality vessels.