ST Engineering - Majority of orderbook still very secure

We are turning more cautious on STE’s earnings outlook, in the face of the most challenging economic conditions seen in over two decades. We are therefore tempering our earnings growth forecasts, due to a higher assumption of provisioning for bad debts on some of its contracts.

We have assumed higher risk mainly on contracts with 1) non-sovereign customers, 2) riskier country profiles and 3) non-defence related contracts. We are also factoring in lower earnings from non-orderbook business in the aerospace division, where conditions are still challenging.

We see increased risk is to geographies such as Greater China and the Middle East. Shakier business segments include low-cost airlines and aviation in general. However, these contracts still represent less than 5% of STE’s overall orderbook, and are tempered by STE’s own risk controls.

FY09 earnings are therefore trimmed by 7% to S$480.7m, which implies modest 1.5% growth YoY. FY10 earnings are similarly cut by 7% to S$508.0m. STE’s orderbook stands at S$10.6bn, of which it expects to deliver S$3.6bn for FY09, or about 66% of our turnover projection.

STE continues to trade at some of the highest valuations in the Singapore market. Price to book ratio stands at 4.6x versus the STI’s 2.4x, and FY09 PER stands at 14.0x versus 7.3x for the index. While we believe that premium valuations are justified due to STE’s outstanding track record, any disappointment or underperformance from the company will negatively impact the share price more severely.

STE has re-affirmed it will still pay out 100% of earnings as dividends. However, along with our earnings cut, we are raising our risk-reward threshold by pegging a minimum 6% yield from FY09 projected dividends. This generates a target price of S$2.70, from $3.60 previously. With an upside of 20% and dividend yield of 7.7%, we maintain our Buy call.

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