ST Engineering - Order book: more than meets the eye

STE routinely secures orders which it does not announce, due to client sensitivities. We estimate these ‘secret’, mostly defence-driven contracts amount to about S$485m in a typical quarter, but have recently risen to a multi-year high. On our estimates, the value of unannounced contracts exceeded S$1bn on 3 occasions in the last 5 quarters. Q109 order book was at a record S$11bn. Rising customer advances support our case: though only S$7m of contracts were announced in Q109, total customer advances increased by S$250m to a record S$1.34bn.

Our findings suggest ‘windfall’ orders of over S$2.1bn, which translates into additional S$267m net profits STE could book in over the coming years. The size of the non-commercial orders secured lately suggests the market might be overlyworried about the aerospace business and underestimating the quality of STE’s future earnings stream.

STE trades at 16.4x on 1-year forward earnings, and close to its minus-one standard deviation of 15.8x (Jan 2000-present). Moreover, based on our recent interactions with management, we believe that the company remains committed topaying 100% of earnings in dividends.

We continue to derive our PT using DCF-based methodology, but now explicitly forecast long-term valuation drivers using UBS’s VCAM tool.

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Hyflux - No rights issue and share placements

The recent spate of rights issues and share placement deals has prompted some market talk of Hyflux being the next in line, given the relatively high gearing ratio of the Group. However, in our recent discussion, management has stated categorically that there will be no such development in the near future as they do not see the need for it.

We agree with management that despite a net gearing ratio of 0.8x currently, there is no cause for concern. Even with a $300m Medium Term Note programme in place since June 2008, the Group has only drawn down $23m so far in the previous two months at the bankers’ request. The rates were at 4-5%, which we believe is favourable.

The share price of Hyflux Water Trust has risen 47% year-to-date to $0.52 currently. With the implied dividend yield moderating to a more realistic 10.7%, the trust is now in a better position to absorb yield accretive BOT projects from Hyflux. This continues to be important to Hyflux’s capital recycling strategy.

Following the cessation of its Middle East joint venture with its Dubai partner, Istithmar in 2006, the latter has been selling down its 9.7% stake in Hyflux. Management believes Istithmar has exited completely, following some private placement deals recently. We believe this removes a major share price overhang. In its place, Japan Gas Corporation, whom similarly has a presence in Algeria, now owns 2-3% of Hyflux.

We have rolled forward our SOTP valuation to FY10, lifting our target price to $2.63 in the process. Valuation for its international peers such as Veolia has improved substantially since our initiation report in April. Despite its smaller, we continue to believe Hyflux should be traded at a premium with its better growth potential and lower cost base.

Olam International Ltd: Shopping for distressed assets

Revives acquisitions pipeline. Olam International Ltd (Olam) has acquired the tomato processing assets of SK Foods, a California-based company which has filed for bankruptcy protection, for US$39m (~S$58m). The cash transaction will be funded internally and Olam will not assume any debt arising from the purchase. The acquisition is small relative to Olam's 9M09 cash position of S$390.5m. Furthermore, with the additional S$437m proceeds raised from its recent equity placement to Temasek, this is probably just the start of a series of acquisitions that we can expect from Olam in the near future.

Opportunistic acquisition reaps synergy. The acquisition is a bargain at US$39m vs. its replacement cost of US$130m. Assuming net profit margins of 5%-9%, the deal is priced at an undemanding 2.2x-3.9x PER. Olam expects this acquisition to accelerate its entry into the US tomato processing industry, given that SK Foods was a dominant player ranked 2nd among US tomato processors and top 5 globally. With a processing capacity of 1.5m tons, its output accounts for 14% of the US market share and 5% of the global market share. The acquisition is expected to reap synergies on several fronts. For instance, it not only enlarges Olam's customer base, but also allows Olam to cross-sell tomato products to its existing customers. Other synergies can be derived from shared overheads and new product adjacencies.

Earnings accretive in the further future. We do not anticipate significant near term financial impact from the transaction. The acquisition is expected to be earnings accretive only from FY12 onwards and is expected to generate revenue of US$200m per year with an EBITDA margin of 12%-13% in steady state, higher than the group's current EBITDA margin of 5%. The incremental revenue translates to 3.3% of FY09F revenue. We are keeping our FY09 and FY10 estimates unchanged. Olam's share price has more than doubled since March and is trading at 26.1x FY09F PER vs. the STI's 16x, after taking into account near term dilution from its recent equity placement. Current valuations no longer provide an attractive entry level, in our view. Nevertheless, given its enhanced prospect of inorganic growth, we are keeping our HOLD rating intact. We are raising our peg to 20x (from 17x) as Olam revives its inorganic growth plans, deriving a fair value estimate of S$2.37 (previously S$2.01).