ST Engineering

DMG & Partners Research, July 2

WE initiate coverage on ST Engineering (STE) with a "buy" rating. Based on our discounted cashflow (DCF) model and assuming a terminal growth rate of 1.5 per cent and weighted average cost of capital of 8.4 per cent, we derive a $4.70 target price.

STE is a company with a solid track record and good growth potential. Given its 4.4 per cent dividend yield, we see the stock's catalyst coming from yield-seeking investors who may have exited Reits as treasury bond yields spike.

The Singapore market has been sold down recently, with the Straits Times Index correcting some 8 per cent since late May. More notably, the S-Reit sector has slipped 16 per cent over the same period, sparked by fears of interest rate hikes.

We believe that yield-seeking investors would be flocking to defensive industrial counters such as STE, which also provides an appealing 4.4 per cent yield and would be less affected by rising interest rates given its net cash position.

Investors are increasingly seeking defensive stocks with strong cash flow. STE is a defensive counter given its: i) track record of resilient earnings, ii) diversified business model, and iii) mix of government and commercial businesses.

We see the company, with its historical 10-year earnings compound annual growth rate (CAGR) of 5 per cent, chalking up 4.1 per cent earnings CAGR over the next five years.

STE's defensive nature will also reinforce its ability to maintain its dividend payout.

STE's largest segment, aerospace, accounted for 32 per cent and 44 per cent of 2012 group topline and net profit respectively.

This segment's outlook is robust, with: i) a global passenger CAGR of 5.0 per cent from 2012-16, ii) cargo growth CAGR of 4.2 per cent from 2012-16, iii) 10-year aircraft fleet CAGR of 3.8 per cent till 2023, iv) 10-year maintenance, repair and overhaul expenditure CAGR of 3.1 per cent till 2023, and v) demand for 1,793 converted freight aircraft over the next 20 years.

STE boasts solid fundamentals, with a 31 per cent ROE, 10-year EPS CAGR of 5 per cent, and is sitting on net cash. Its share price, which has pulled back by about 10 per cent from its recent peak in late April, is now trading at a 20.6 times FY2013 PE, 16 per cent below its historical 24.5 times peak.

BUY