• ST Engineering’s first quarter net profits came at S$134 million, posting a paltry loss of 0.3% y-o-y, which represents 22% of consensus full year forecast.
  
• The firm’s aerospace sector contributed positively to its bottom-line, with profitability growing 26% y-o-y due to encouraging sales mix, favourable foreign exchange impact and higher profits from associates.
  
• On the other hand, 1Q ’13 earnings contributions from its Electronics, and Marine sectors were only comparable to that of 1Q ’13, whereas its Land Systems sector profitability was lower (-9% y-o-y), due to unfavourable product mix and allowances for inventory obsolescence and doubtful debts. Absence of contribution from an associate with profit from Singapore Airshow 2012 also hurt performance.
  
• Nevertheless, its order book grew to S$13.0 billion, up from S$12.1 billion recorded in 4Q ’12.
  
• Management guided to achieve higher revenue and profits before tax for FY 2013, compared to FY 2012, and deliver S$3.6 billion of its order book within 2013.

Defence’s Turn in the Limelight

Defence outlook complementing commercial – reiterate BUY. We reiterate our BUY call on ST Engineering (STE), as a positive defence business outlook lends support to the thesis that it should trade at a premium to its historical average. We maintain our target price at SGD4.40, pegged to 21.6x FY2013 PER, 1 standard deviation above its historical mean. STE’s orderbook, expected to reach record heights again in 1Q13 continues to provide clear earnings visibility, together with a healthy dividend yield of 4.4%.

MINDEF and other defence contracts take centre-stage. Two of STE’s largest contracts announced to-date have been derived from its defence business, and both from its Marine arm. The first, an SGD880m contract for 4 naval vessels from the Royal Navy of Oman, followed by a Jan 2013 contract with MINDEF for 8 patrol vessels, which we estimate to be worth ~SGD1.8b. We continue to see healthy defence expenditure trends both in terms of Singapore (CAGR 4%) as well as from STE’s overseas customers (CAGR 4-5%).

Four business segments a formidable mix. We also maintain that each of ST Engineering’s four business segments of aerospace, marine, electronics and land systems have clear skies ahead in terms of business outlook. Commercial contracts (63% by total FY2012 revenue) such as aerospace MRO, electronics’ rail and road systems, marine shipbuilding continue to complement the defence business and maintain a healthy record of contract wins.

Reiterate BUY, 1Q13 orderbook catalyst on the way. We reiterate our BUY recommendation on STE, with a view towards its 1Q13 orderbook setting yet another record (~SGD13b), providing the earnings visibility that would catalyse its share price appreciation. Our target price of SGD4.40 remains pegged to 21.6x FY2013 PER, 1 SD above its historical average. Investors who own the stock before Ex-Div on 26 Apr will stand to enjoy SG 13.8 cts / share of dividends (translating to ~3.3% yield).

More to look forward to

• FY12 net profit of S$576m (+9% y-o-y) in line; final dividend of 13.8Scts (FY12: 12.5Scts)
  
• Upside to end-FY12 orderbook of S$12.1bn from recent Singapore navy contract
  
• MRO revenues recovering; potential for upside surprise from pick up in US operations
  
• Valuations have not peaked; maintain BUY with higher TP of S$4.40
  

Strong earnings growth in FY12. Results for 4Q12 and FY12 were in line with estimates. STE reported net profit of S$576m for FY12, up 9% y-o-y on the back of 6% growth in revenue to S$6.4bn. Earnings were mainly driven by Aerospace and Electronics segments, but all divisions showed improvement. Results would have been better if not for higher allowances for doubtful debts, impairment of goodwill and higher tax charges. Group PBT margin remained stable at 11%. Aerospace margins improved to 15% despite start-up losses at new projects.

Potential upside to orderbook, earnings. STE finished the year with an orderbook of S$12.1bn, but this could be boosted by another S$1.5-2bn (our estimate) from the recently secured contract to build 8 patrol vessels for the Singapore Navy. We conservatively expect earnings growth of about 6% p.a.in FY13/14F, but there is upside potential from the MRO division, where business has been picking up, especially in the US.

Maintain BUY; room to re-rate further. While the stock is currently trading at 20x FY13 PE, it is still below the +2 S.D. level, unlike some of the other dividend yield names in the market. In terms of yield spreads, we are still not quite close to the previous peaks. With yield compression in vogue, we reckon there is room for further upside. Thus, we maintain our BUY call on STE with a revised TP of S$4.40, premised on higher valuation metrics, as justified above. With healthy earnings growth of about 6% and yield of about 4.5%, we believe the stock still presents one of the more compelling investment cases among the defensive, dividend yield names listed on the SGX.

Naval contract win to drive up valuations

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 an anchor customer of Singapore’s defence industry.

• Net income of S$576.2mn (+9.2%y-y).
  
• Expect order book to hit new record in the next quarter.
  
• Guidance for higher sales and profit in FY13E.
  
• Dividend payout remains at 90%.
  
• Maintain Accumulate with revised TP of S$4.50.
  

What is the news?

STE reported a strong 9.2% growth in net income on record sales of S$6.4bn in 2012. Revenue was higher across all divisions with profitability remaining little changed from the year earlier. Order book trended lower on a sequential basis to S$12.1bn (1.9X sales). The company maintained its historical payout ratio of 90% and recommended a full year DPS of 16.8cents (FY2011: 15.5cents). Management guided for stronger sales and profits in FY2013. Separately, the company recently announced a major shipbuilding contract for the Singapore Navy.

How do we view this?

The results beat our forecasts largely due to a stronger than expected end to the year. The company’s order book softened sequentially, but we expect it to hit a new record high in the next quarter after addition of the recent

shipbuilding contract for the Singapore Navy. While the contract value was not announced, we estimate it to be worth approximately S$2bn.

Investment Actions?

Despite the strong rally over the past year, we expect the stock of STE to continue trading towards the top end of its historical valuation range in the year ahead. We raised our target price to S$4.50 as we roll over our valuation basis to FY13E. Maintain Accumulate.

FY12 In-Line; Looking Forward to 1Q13

FY12 PATMI up 9.2%, 1Q13 to provide boost. ST Engineering (STE) reported FY2012 PATMI of SGD576m (+9.2% YoY), which was in-line with expectations, as growth was driven primarily by the Electronics (+10% YoY) and Aerospace segments (+9.3% YoY). Final and special dividends totaling SG13.8 cts/sh were declared, bringing full-year yields to ~4.2% p.a. We believe 1Q13 will be one to look forward to given the positive newsflow of a record orderbook once the recent MINDEF contract for 8 naval vessels is factored in. Upgrade to BUY, TP of SGD4.40 now based on a higher 21.5x FY2013 PER.

SGD12.1b orderbook belies true worth. We believe that the recent vessel design and build contract awarded by MINDEF could have a value in the region of SGD1.8b, and hence pave the way to yet another record orderbook of ~SGD13b to be announced in 1Q13. We had mentioned in our previous report that we were waiting for STE to once again show signs of outdoing itself in orderbook size before upgrading our valuation metrics, and this contract looks to fit our criteria.

Margins inching up. Another positive sign was the general trend of improvement in terms of profitability margins, which helped boost STE’s bottom-line in addition to the 6% YoY improvement in revenue.

Outlook positive. Management’s guidance for 2013 was largely positive, as the Aerospace, Electronics and Marine sectors were expected to record higher PBT YoY, while Land Systems was expected to maintain comparable profitability.

Going from strength to strength: Upgrade to BUY. Although STE’s share price has seen recent strength, we still see more up-side for a company we expect will provide further positive guidance in 1Q13 especially in terms of its orderbook. In light of firmer earnings visibility, we are raising our profit forecasts by 4-5% for FY2013-15 and upgrading STE to a BUY as we believe it now deserves a valuation pegged to 21.5x FY2013 PER (1 SD above historical mean).