ST Engineering: Approaching target

Recording higher earnings QoQ. ST Engineering (STE) saw flat 1Q09 revenue while net profit dropped 30.4% YoY as mainly attributed to lower contributions from the Aerospace division. However, on a QoQ basis, profit before tax (PBT) had actually increased 25% to 1Q09. Stripping out the S$34.4m tax write-back seen in the previous quarter, net profit would have improved 25.5% sequentially, below our expectations.

Generating strong cash flows. STE continued to see robust operating cash in 1Q09 where FCF per share translated to 9.9 S¢, notably higher than its EPS at 2.8 S¢. Management also assured that worries over its cash flows being "artificially" boosted by advance payments from customers were unfounded. As STE continues to secure new contract wins, cash flows from these clients would thus not be lumpy.

Outlook seen to be improving. Management highlighted that its 1Q09 results are not reflective of the entire year as they believe that the next nine months would see better margins which in our view is mainly due to its Aerospace business. STE also added that based on historical trends, its 2H has usually been better than its 1H ? we therefore expect its current record order book at S$11.0b (from S$10.6b in FY08) to increase even more going forward.

Maintaining earnings estimates, but downgrading call. We forecast earnings to contract 1.8% to S$465.2m in FY09, before growing 10.8% to S$516.0m in FY10. At S$2.63, it trades at 17.0x FY09 and 15.3x FY10 P/E. Over the past five years, it has been trading at an average of 19x P/E. Its dividend yield of 5.9%, while above that of the STI's 3.8%, is not particularly palatable for a high yielding counter. Based on our DDM, we derive a target price of S$2.83. Given the limited 7.7% upside, we are downgrading the stock to NEUTRAL.

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