Robust Outlook To Support Lofty Valuations

• Despite premium valuations, ST Engineering (STE)’s defence and commercial-driven record order book of SGD13b, along with a potential catalyst in the form of a major billion-dollar contract, continue to justify a BUY rating. As a heuristic gauge of the stock’s valuation, STE trades at an undemanding market capitalisation-to-order ratio of 1.0x, below its market cycle average of 1.2x. Our target price of SGD4.80 is based on 23x blended FY13/14 PER.
  
• STE is in the running for a major contract from the US Coast Guard (USCG), which could be worth c.USD10b. This could be announced as early as 3Q13. Closer to home, a recent Singapore Navy patrol vessel contract could be its biggest since 2008.
  
• ST Aerospace’s recent acquisition of a 35% stake in EADS EFW, a Centre of Excellence for freighter conversions, is meant to leverage on its years of experience in passenger-to-freighter (PTF) conversions. It plans to develop a conversion package for two versions of converted freighters – A330-200P2F and A330-300P2F – where there is a major market opportunity, as Airbus estimates that 847 mid-sized aircraft would be converted into freighters over the next 20 years.
  

REDUCING PEG FROM 22X TO 20X

• Sell-down along with broader market
  
• Risk-off approach for market
  
• Cut FV to S$3.97
  

Recent sell-down

As part of the recent general sell-down in the market, STE’s share price has fallen 12.1% since the peak of S$4.56 on 24 April 2013. But we note recent contract wins that attest to the group’s market leading positions. Just yesterday, ST Aerospace announced that that it has signed a longterm agreement with UTC Aerospace Systems to provide maintenance, repair and overhaul (MRO) services on the Boeing 787 Dreamliner nacelle systems for the Rolls-Royce Trent 1000 and General Electric GEnx engines. This follows a string of ST Aerospace announcements on 18 Jun, including an eight-year component MBHTM agreement with Spring Airlines Japan.

Solid 1Q13 despite no airshow

To recap, STE reported 1Q13 results that were in line with ours and consensus expectations. Revenue grew 0.2% YoY to S$1.54b, and PATMI fell 0.3% YoY to S$134m. PBT margin for the group stayed flat YoY at 10.5%. Highlights include: 1) lack of the biennial Singapore Airshow in 1Q13, which contributed to a S$6.1m drop in share of results of associates and jointly controlled entities, 2) growth in administrative expenses by S$7.9m (7% YoY) due to increased headcount from new Aerospace subsidiaries. STE’s order book reached a new high of S$13.0b as of end-Mar 2013, of which S$3.6b is expected to be delivered in the remainder of 2013.

Better outlook for 2H13

STE continues to anticipate achieving higher revenue and PBT in FY13 versus FY12. For 1H13, STE expects higher revenue and comparable PBT YoY. These suggest that 2H13 is likely to be strong for the group.

Maintain HOLD

Nevertheless, as the market seems to be in a more “risk-off” mode, we lower our FY13F EPS peg to 20.0x (versus 22x previously), which results in our fair value easing to S$3.97 from S$4.36. We maintain a HOLD rating on STE, supported by an estimated FY13 dividend yield of 4.4%.

Defensive play with leverage to cyclical recovery in the US

• Recent sell-down is unjustified; stock offers upside from US recovery, backed by an attractive yield
  
• Visible growth drivers in place at Aerospace, Marine divisions; in Asia as well as in the US
  
• Strong balance sheet and net cash position drive M&A ambitions; beneficiary if interest rate rises
  
• Proxy to recovery in the US and appreciating US$. Maintain BUY,TP S$4.80
  

Enviable track record. We recently met up with 35 fund managers on a roadshow in the US with STE’s management team. Investors are generally impressed with the group’s track record over the past 10 years, chalking up revenue CAGR of 9.3%, net profit CAGR of 5.7% and EVA of 8.7%. Current shareholders have done well to enjoy the ride on ST Engineering’s sterling share price performance over the past 12 months, the stock generating total return of 32% (including dividend yield) notwithstanding the recent pullback.

Strategic growth drivers in place. Key discussion topics during the roadshow revolved around the group’s strategy for growth and possible changes in revenue mix in the next 5 years. Near term growth will come from acquisitions in Aerospace (PTF conversions in Europe), new hangar facilities in Guangzhou and engine workshop in Xiamen, and expansion into the shiprepair business in the US. Armed with a net cash chest of more than S$500m, the group is well positioned to source for M&A for longer term growth. Management’s key concern would be to negotiate an environment of rising cost pressure in Singapore due to the curbs on foreign labour, to ensure the group’s competitiveness in the global arena.

Maintain BUY, TP of $4.80. STE has no exposure to a potentially rising interest rate environment globally, and hence STE remains our preferred pick, offering strong earnings visibility from its record order book of S$13bn, steady earnings growth of 6% and dividend yield of 4.6%. The stock is a proxy to recovery in the US economy with 27% of sales from the US. Appreciation of the US$, if sustained, will provide earnings upside. Catalyst for stock performance will come from sustained order win momentum, going forward.

Record order book, Positive guidance maintained

Company Overview

ST Engineering (STE) is an integrated engineering group with exposures to four key business segments: Aerospace, Marine, Electronics and Land Systems. The company is also a key contractor to Singapore’s defence force.

• Net income of S$134.0mn (-0.3%y-y).
  
• Record high order book of S$13.0bn.
  
• Positive full year guidance maintained.
  
• Maintain Accumulate with unchanged TP of S$4.50.
  

What is the news?

STE reported net profits of S$134.0mn in 1QFY13 on sales of S$1,544.7mn. Revenue was little changed on year as higher sales from other segments were offset by a 6% decline in sales for the Electronics division. Profit growth was the strongest at the Aerospace segment as the division benefitted from a 2.6% improvement in PBT margins. Management guided for higher revenue and comparable PBT in 1H2013 compared to 1H2012, while maintaining their full year guidance for higher revenue and PBT.

How do we view this?

While the results were slightly disappointing as compared to the same period last year, we believe that seasonal contributions from the biennial Singapore Airshow did create a higher basis for comparison. By maintaining their guidance of profit growth for the full year, management have implicitly guided for a strong set of 2HFY13 performance.

Investment Actions?

We expect a neutral stock reaction to the results and maintained our Accumulate rating and TP of S$4.50. With our assumption of a 90% dividend payout, we expect the stock of STE to yield an attractive 4.1% in FY13E.

Record order book, Positive guidance maintained

Company Overview

ST Engineering (STE) is an integrated engineering group with exposures to four key business segments: Aerospace, Marine, Electronics and Land Systems. The company is also a key contractor to Singapore’s defence force.

• Net income of S$134.0mn (-0.3%y-y).
  
• Record high order book of S$13.0bn.
  
• Positive full year guidance maintained.
  
• Maintain Accumulate with unchanged TP of S$4.50.
  

What is the news?

STE reported net profits of S$134.0mn in 1QFY13 on sales of S$1,544.7mn. Revenue was little changed on year as higher sales from other segments were offset by a 6% decline in sales for the Electronics division. Profit growth was the strongest at the Aerospace segment as the division benefitted from a 2.6% improvement in PBT margins. Management guided for higher revenue and comparable PBT in 1H2013 compared to 1H2012, while maintaining their full year guidance for higher revenue and PBT.

How do we view this?

While the results were slightly disappointing as compared to the same period last year, we believe that seasonal contributions from the biennial Singapore Airshow did create a higher basis for comparison. By maintaining their guidance of profit growth for the full year, management have implicitly guided for a strong set of 2HFY13 performance.

Investment Actions?

We expect a neutral stock reaction to the results and maintained our Accumulate rating and TP of S$4.50. With our assumption of a 90% dividend payout, we expect the stock of STE to yield an attractive 4.1% in FY13E.