Target price: SGD3.78 | BUY | Upside 10%

A shield against global worries. Recent contract wins have helped cement our view that STE remains one of the top defensive picks for investors concerned about global macro uncertainties. STE’s strong orderbook, helped in no small way by its defence contract capabilities, provides earnings visibility and supports an attractive forward dividend yield of 5-5.5% p.a. Our BUY call has worked out quite well since our upgrade in April, with a ~10% total return on investment. With a target price of SGD3.78 pegged to mid-cycle valuations of 19x FY2013 PER and the best yet to come, we maintain our BUY call.

FY2012 in the bag; FY2013 looking good. SGD179m in contracts recently announced by ST Marine reaffirms strong contract win momentum despite the tough economic conditions. This brings its total orderbook closer to SGD13b, of which ~SGD2.5b (40% of our FY2012 revenue forecast) is expected be booked in 2H2012. With 1H2012 revenue of SGD3.1b (50% of FY2012 forecast), we believe our FY2012 revenue forecasts are in the bag. As we expect the strong momentum to continue, FY2013 is also looking good.

Conservative margin assumption suggests upside to earnings. We have assumed a 9% net margin for our FY12-14 forecasts, but there may be upside potential as these are conservative assumptions that mirror operating conditions immediately after the Great Financial Crisis of 2008-09. STE’s earnings resilience comes from diverse businesses that help shield it from sector-specific shocks. Historically, they have given earnings a complementary mix of stability and profitability.

The cycle is still on STE’s side. We believe Aerospace and Marine still have upside in their respective cycles, as the aviation MRO industry is expected to benefit from the proliferation of airline capacity, and high oil prices are keeping activities in the offshore sector positive. For Electronics, government initiatives to enhance the local rail transport network are improving contract win visibility, while Kinetics will continue to be underpinned by steady defence-based contracts.

Record Orderbook keeps on rolling

SGD179m added to the mix. ST Marine has recently secured new contracts, mainly comprising SGD111m from two OSV options exercised as part of a previous Nov 2011 Hornbeck Offshore order. The remaining SGD68m are from repair and upgrading works which support oil and gas exploration activities. With these contract wins, it pushes STE’s estimated orderbook just shy of SGD13b, out of which ~SGD2.5b is expected to be delivered in 2H2012.

Together with 1H2012 Revenue of SGD3.1b, our FY2012 revenue forecasts look to be in the bag with ~90% secured. We also assume that the strong orderbook growth momentum will continue into FY2013.

Margins resilient; possibility of upside

Orderbook complemented by healthy margin record.

STE’s segment profitability margins support two key determinants of its resilient earnings:

(1) Diversity in core businesses help to shield STE from sector-specific shocks.

(2) Complementary mix of stability and profitability:

• Stable but lower margins: ST Electronics and ST Kinetics
• Volatile but higher margins: ST Marine and ST Aerospace.

Furthermore, our conservative PATMI margins of ~9% for our FY12-14 forecasts suggest that there could be room for earnings upside given that margins look to be in a recovery trend from troughs of ~8% during the 2008-09 financial crisis.

Aerospace soaring

Aerospace still robust. The current outlook for Aerospace MRO continues to be positive, with global forecasts of MRO spend growing at ~4% CAGR for the next 5 years, supported by a ~3% CAGR increase in aviation capacity globally. Although ST Aerospace contributes just a third of total group revenues, it consistently contributes more than 40% to group PBT and this underscores its importance to the group.

Electronics enjoying rail support

Beneficiary of rail network expansion. The recent push by the government to improve Singapore’s rail transport network, topped off with the announcement of the Thomson Line MRT project, would serve to benefit ST Electronics through its MRT-related contract capabilities. Although the Thomson Line is only slated for completion within a longer 8-10 year horizon, this provides earnings visibility in terms of ST Electronics’ project pipeline continuing on from the current Downtown line works which comes on-line in stages from 2013-2017.

Based on its recent contract wins and an illustration of its comprehensive suite of MRT-related capabilities, we believe ST Electronics to be well poised to benefit from Singapore’s push for rail network expansion. Add to that its significant competitive advantages in the market which we detail on the following page, ST Electronics should prove to be one of the ST group’s more stable earnings contributors.

Incumbent with competitive advantages. While ST Electronics is subject to a competitive tender process when bidding for land transport electronics contracts, it possesses a few key advantages over potential new entrants into the market that enable it to maintain its market leadership (ST Electronics has a significant 80% market share in terms of train electronics):

1) Excellent track record

• Large government tenders often require a track record of working on similar projects in a local context as well as an impeccable history of work safety. This criteria alone would sieve out many potential competitors.

2) Economies of scale:

• With an international workforce of over 5,000, out of which 20% are overseas and 70% are engineers, it enables ST Electronics to maintain flexibility and synergies within its human resources.
• In addition, ST Electronics would also have economies of scale for equipment and other production resources.

3) Compatibility with existing systems:

• With the increasing complexity and overlap of train routes across the different rail networks, it would be ideal for these new lines to exhibit compatibility across the entire network. Being the incumbent with 80% market share in train electronics, ST Electronics certainly has the advantage.

4) 'Mission-critical' (Military-grade) system capabilities:

• ST Electronics prides itself on being able to deliver ‘mission-critical’ systems incorporating both hardware and software, possibly through synergies with its military projects. Having the capability to design systems of such demanding standards certainly gives ST Electronics a credentials boost.

Hard-as-steel resilience, maintain BUY

A shield against global worries, maintain BUY. Recent contract wins and the government’s new rail infrastructure commitments have helped cement our view that STE remains one of the top defensive picks for investors concerned about global macro uncertainties. STE’s strong orderbook, helped in no small way by its defence contract capabilities, provides earnings visibility and supports an attractive forward dividend yield of 5-5.5% p.a. We maintain our BUY call, with Target Price of SGD3.78 pegged to 19x FY2013 PER.

Source: Maybank Kim Eng Research - 13 Sep 2012