ST Engineering - Defensive growth

Deliveries of new generation airframe and engines, as well as OEM’s after-sales service, were investors’ top concerns during our recent one-week NDR in Toronto and the US. We believe demand for airframe MRO will be firm in the medium term, backed by ageing fleet, extended operational life of older aircraft on lower oil prices. Engine shop visits could surge by 2016, as maintenance cannot be deferred indefinitely.

We see recent share price weakness as a buying opportunity. STE is trading below its 7-year mean (19x). Potential catalysts include sizeable contract wins in electronics and stronger MRO demand. Maintain Add and target price, based on blended P/E, DCF and dividend yield valuation.

Old fleet still needs MRO
We expect aerospace‟s pretax profit (44% of total pretax profit) to recover by 11% in FY15, with the completion of restructuring exercise in Europe as well as the impairment of cabin interior WIP recognised in 1Q15. Beyond 2015, we think that pretax profit could rise by 5-8%, backed by the ageing fleet and expansion of services offered by aerospace. More than 50% of its major customers‟ fleets are aged 5-20 years, requiring heavy maintenance. The replacement of new aircraft is inevitable but we think the pace will be gradual over the next 20 years. Sustained low oil prices could also boost MRO shop hours, as airlines extend the operational life of older aircraft. STE has expanded its service to include VIP aircraft completion, parting-out of aircraft, engine wash, manufacturing of seats and engine leasing. We believe engine MRO could return by end-2015, assuming a 20% deferment in life cycle from 5.7 years (50,000 hours) to 6.8 years for the CFM56-7 engines (powering B737-800 fleet).

Urbanisation heat is on
We expect electronics, the second-largest pretax profit contributor (23% of total pretax profit) to deliver 8% growth p.a., as it executes the strong contract wins (S$2.2bn) in 2014. The division posts the highest ROE, given its low capex and scalable model, not constrained by hangar/capacity expansion. It is well positioned to benefit from urbanisation infrastructure spending by Asian government agencies for “smarter” nation, mass-rapid transit, tightening of cyber security and disaster recovery systems.

Technical Analysis
Daily Chart
Valuable ‘land’ systems
Land system earnings have likely troughed with significant provisions made for commercial vehicle inventory in 2014. We estimate that the c.494,000 sq m of land on which its Chinese subsidiaries (GKJ and Jiangsu Huatong Kinetics) reside could fetch c. S$270m, if disposed. (Read Report)

Source : CIMB Research

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