ST Engineering Ltd (OCBC)

Maintain BUY
Previous Rating: BUY
Current Price: S$2.92
Fair Value: S$3.57

10% cap on Ropax contract claims

Receives claim from LDA. ST Engineering (STE) has just updated that its marine arm - ST Marine (STM) - has received a letter of claim (dated 10 Jun 2011) from the lawyers of Louis Dreyfus Armateurs (LDA) in respect of the shipbuilding contract for the Roll-on/Roll-of Passenger (Ropax) ferry that was contracted in Jul 2007 for around S$179m. LDA is claiming for both liquidated and unliquidated damages resulting from STM's purported breach of the Ropax contract amounting to around S$4.8m and EUR33.03m, respectively. However, STM has referred the matter to its legal advisers and it intends to dispute the claim as it is of the view that LDA's purported termination of the Ropax contract is a breach and STM itself has terminated the Ropax contract because of this breach.

No material impact on financials. But in the event that STM is liable, we understand that STM is required to refund the milestone payments made by LDA (amounting to S$129m plus interest); STM also maintains that under the contract, its total liability is capped at 10% of the contract price. As such, STE also does not expect the contract termination to have any material impact on its NTA or EPS for FY11. Meanwhile, we note that the milestone payments (excluding interest and damages) are just 2.2% of STE's FY10 revenue, and we also understand that the group has been making provisions for this particular vessel since missing the stated delivery date.

Sell or lease vessel when completed. We also understand that the group is going ahead with the completion of this vessel; and this will give STE the option of either reselling it in the secondary market or chartering it out to third party operators. However, as the Ropax is likely to be quite highly customized, we note that there may be a need for STE to refit the vessel to new specifications or face a longer time before it can find a suitable buyer or charterer. But from recent transaction reports from shipbrokers, we understand that the demand for RoRo (Roll-on/Roll-off) vessels remains relatively buoyant.

Maintain BUY. As before, we think it is still early days to assess if STE/STM has to pay damages, hence we hold off adjusting our FY11 estimates. Our worst case scenario could see a <5% impact on FY11F pre-tax profit. We are still positive on the group's overall prospects, defensive nature and do not believe that this incident will affect its strong payout (around 90% of core earnings) ability; hence we maintain our BUY rating and S$3.57 fair value (21x FY11F EPS).