ST Engg’s Q1 profit up 13%

It posts net earnings of $122.5m on the back of an 8% rise in turnover

SINGAPORE Technologies Engineering (ST Engg) yesterday posted net earnings of $122.5 million for the first quarter ended March 31 – a 13 per cent increase from $108.8 million for the corresponding period last year. This came on the back of an 8 per cent rise in turnover to about $1.32 billion, from $1.22 billion in Q1 2007.

Earnings per share rose 11 per cent to 4.11 cents from 3.69 cents. Return on equity also rose to 7.1 per cent from 6.4 per cent.

‘Operationally, very robust,’ said ST Engg’s president and chief executive Tan Pheng Hock of the performance, pointing out that this was achieved in the face of a weaker US dollar and a lower interest rate environment. In addition, the group had to incur expenses for the Singapore Airshow in the first quarter this year.

The land systems sector saw the highest percentage increase in turnover as it raked in $364 million, a 22 per cent year-on-year jump. Turnover for the aerospace and electronics sectors also rose by 3 per cent to $469 million and 6 per cent to $245 million respectively but for marine, the turnover was flat at $198 million.

With Skybus Airlines filing for bankruptcy in April, ST Engg decided to adjust its order book to remove the Skybus contract. The group’s order book was $9.19 billion as a result. ST Engg expects to deliver about $2.89 billion of its order book for the rest of 2008. The group expects to achieve a modestly higher turnover and profit before tax in H1 2008 as well as FY2008, compared with H1 2007 and FY2007 respectively.

Sector-wise, ST Engg’s outlook for the aerospace and land systems sectors are bright, and it expects their H1 2008 turnover and profit before tax to be higher than that of the year-ago period. For electronics, the first-half results are expected to be comparable with those of H1 2007. And for marine, H1 turnover and pre-tax profit may be lower.

Mid-term earnings visibility impaired

• Below expectations. 1Q08 net profit (+13% yoy) came in 13% below our estimate and 11% below consensus, forming 22% of our FY08 forecast. The gap could be explained by a depreciating US$ and slower-than-expected growth at Electronics. Stripping out forex, pretax profits would have been S$5.5m higher.

• Aerospace hurt the most by weakening US$. The bulk of Aerospace’s revenue is denominated in the US$. Although utilisation at its US operations remained high and not much pricing pressure was felt, the depreciating US$ was a drag on revenue translation. In 1Q07, the average translation rate was S$1.57/US$; this became S$1.42/US$ in 1Q08. Margins dipped to 18% from 20% mainly on lower sales and higher expenses incurred for the Singapore Airshow and the development of new prototype products. We believe 2Q08 will be stronger with more project redeliveries, especially the Fedex 757 PTF and 767BCF for ANA.

• Electronics affected by iDirect and lack of associated income. The weaker performance at iDirect was due to a delay in product launches to 2H08. The disposal of ECS in 4Q07 also reduced associated contributions. Management has guided for a flat 1H08. On the back of this, we are lowering our FY08 turnover forecast by 5% and projecting slower growth for FY09-10.

• Land Systems surprised positively, led by defence contracts. Earnings came in above our expectations due to higher margins achieved for military contracts and stronger weapons and munitions sales, though these were partially offset by lower earnings from its special vehicles division in the US.

• Order book remained strong at S$9.2bn, with about S$4.2bn for recognition in FY08, representing 73% of our forecast. The order-book balance is net of a S$1bn contract loss from SkyBus as the latter filed for bankruptcy recently. Order-win momentum in 1Q08 was still strong with new contracts of about S$1bn.

• Maintain Neutral; target price reduced to S$3.70 from S$4.01. Earnings estimates cut by 1-3% for FY08-10, to reflect slower growth at Electronics. Our target is still based on blended valuations but we discount our P/E by 20% to 16x from 20x and reduced the LTG in DCF to 1% from 2% on the back uncertainty. Given STE’s sensitivity to US$ weakness and a sluggish US economy, its mid-term earnings visibility has been affected. However, dividend yield is attractive at 6%.

Aerospace facing headwinds

Story: 1Q08’s net earnings of $122.5m (+13%) were in line, accounting for 22% of our full year forecast. However, EBIT’s growth of 3% was disappointing, net earnings were lifted by investment income, and lower effective tax rate.

Point: Aerospace disappointed, as the effects of a slowdown in US airlines and weak US$ dampened revenue growth (+3%) and EBIT margins (-1% to 14%). PBT would have dipped 5% if not for an investment gain of S$11.5m. Group incurred forex loss of S$4m. The only bright spot was Land Systems, which saw sales rising 22%, driven by a 72% growth in M&W division. Better product mix in M&W led to PBT growth of 34% and PBT margin expansion by 1 ppt in 1Q08. The Marine sector saw a 10% dip in PBT as the frigate contract is near completion and demand for shipbuilding activities reduced in the US. PBT margins declined in the Electronics group as well, from 9.6% in 1Q07 to 8.2% in 1Q08 owing to delay in launch of iDirect’s new product and divestment of ECS. The Electronics segment should rebound in 2H08, though,with the launch of new products in iDirect by end-June.

Relevance: We have revised our FY09 earnings estimates by 5% on the back of lower growth forecasts in the Aerospace sector as the lag effect of US airlines seeking to cut MRO budgets, will be felt from 2H08. Tough operating environment has resulted in the termination of four budget carriers and the merger of Delta and North-West. Margins will be pressured by a weak USD – every 1% drop in the US$ affects PBT by S$1.6m. We have cut our SOTP based target price to S$3.50, and maintain our HOLD recommendation in the absence of any near-term growth catalysts. Stock price should be supported by strong order book of S$9.2b (down from $9.5bn adjusted for the loss of Skybus contract), high ROE of 31.5% and dividend yield of 5.6%.

Aerospace growth weakens, Defense surges

Top line and bottom line growth masks weak growth at Aerospace– 1Q08 revenue increased by 7.8%yoy, while PBT rose by 6.2%yoy due mainly to a surge in profits from Land Systems(+34.3%) and higher investment income(+72.2%). Net profit rose by a higher 12.6% due to lower tax provisioning. On a QOQ basis, PBT fell by 11.9% due to lower margins on Aerospace and Marine division. The former was affected by a weak US dollar and translation losses accounted for roughly $4.3m. We are concerned with the slower growth at the Aerospace division, which accounts for the bulk of Group pre-tax profits. Aircraft maintenance and engine overhaul subdivisions which are the largest business units showed pre-tax declines underscoring our concerns that troubles in the airline sector would impact the Aerospace division. It remains to be seen whether the other divisions will pick up the slack. Thus far, Land Systems has done so. For now, we maintain our Hold Recommendation but lower our price target to $3.30 or 19x forward earnings to reflect the uncertainty at Aerospace division.

Growth from Defense related Land systems.- Revenue for the division grew by 21.3% while PBT rose by 34.3%. PBT growth for the division was due to a 170% increase in munitions & weapons pre-tax profit to $24.2m. Excluding this surge, Group PBT would have actually declined. The Electronics division- The division showed a modest 2.1% decline to lower operating profits form satellite communication equipment sales as well as lower associate contribution. Marine division – The division declined in line with guidance as higher margin defense related works ceased.

Slower top line and bottom line growth from Aerospace– The division which still accounts for 53% of group PBT grew by just 2.8% yoy against our full year expectation for 8.7% yoy growth. Revenue from Aircraft Maintanenance & modification(AMM) fell 2.7%, while PBT fell by 6.1%. Revenue from Component Engine repair & Overhaul (CERO) rose 0.8% while PBT fell by 29.4%, underscoring our expectation of higher margin pressure for the Aerospace division for the year.

Outlook-The electronics division should show higher sales recognition form LTA’s circle line project, while Aerospace division should see the delivery of the 1st Boeing 757 Passenger to Freighter conversion in 2Q08. Management has guided improved 1H08 earnings for Aerospace and Land Systems.

Slower Growth At Aerospace Division

Uncertainties ahead. Management has categorised 2008 as a year of uncertainties in the latest annual report, citing poor economic conditions in the US as a cause. The aerospace division, which accounts for half of the Group’s pre-tax earnings, should see top-line compression as airlines rationalise costs in the wake of steep fuel cost hikes. We are also concerned with the rise in impaired receivables as shown in the latest annual report and have allowed for further write-downs in 2008.

CAGR of 6.8% and projected 95% payout. Despite the potential headwinds at ST Aerospace, we like ST Engineering (STE) for its diversified business units and also its growing track record of expanding into new markets. All the divisions, except for the marine division, are expected to show modest growth over the next two years. Overall, we are looking for three-year CAGR of 6.8% for the next 3 years, compared to the 15% achieved during the previous three years. Dividend payout is projected at 95% for the next three years.

Downgrade to HOLD. We have downgraded our recommendation from BUY to HOLD given the difficult operating environment of the aerospace division. Our fair value is pegged at $3.62 based on DCF valuation. Key attraction is STE’s ability to offer yield of 5% in lieu of low capex requirements. We suggest an entry price of $3.30, allowing for a 10% upside to our fair value.