IATA’s expectations of deeper losses would mean MRO operations are unlikely to recover in 2H09 or even 1Q10. We have cut our 2009 estimates by 9.6% and 2010’s by 8.0%. Fair price is lowered to $2.04.

In the clearest sign that a recovery is unlikely to materialise in 2009, International Air Transport Association (IATA) has raised full-year losses for global airlines to US$9.0b from US$4.7b. Asia Pacific carriers are projected to turn in losses of US$3.3b while North American carriers are projected to record losses of US$1.0b. IATA also expects passenger traffic to decline 7% in 2009 and cargo traffic to decline 17% yoy.

Market has not factored in impact of lowered IATA guidance on MROs. Instead, consensus opinion appears to be factoring in a recovery for maintenance, repair and overhaul (MRO) operators on expectations of an improvement in traffic. IATA’s projection takes into account not just projected traffic decline, but also expectations of lower yields. An earlier industry projection estimated that MRO rates would fall 3.6% in 2009 but this was based on IATA’s forecasts of a 3% drop in passenger traffic and a 5% drop in cargo traffic, which have since been revised downwards. Thus, there is downward scope for MRO rates and not upward.

Lowering 2009 net profit by 9.6%. IATA‘s assessment has negative implications for ST Engineering’s (STE) aerospace division which derives 80% of its revenue from Asia Pacific and North America. Given the dire forecast, we now do not expect margins to improve in 2H09. As such, we have cut our 2009 estimate by 9.6% and 2010’s by 8.0%. We are also mindful that any further weakness in the US dollar would impact ST Aerospace (ST Aero) in 2H09, given that MRO billings are in US dollars. Earnings, however, could be lifted by the improvement in learning curve for ST Aero’s freighter conversion programme for FedEx’s 87 B757-200s. The initial batch of eight aircraft delivered over a nine-month period recorded losses and there is a possibility that the 10-12 aircraft to be converted in 2009 could achieve marginal profitability as ST Aero moves up the learning curve.

Electronics segment buffers impact from lower aerospace contributions. The electronics segment is expected to mark milestone contributions from Land Transport Authority’s (LTA) Circle Line and Taiwan's MRT project in 2009. Contributions from this division and regular defencerelated work are expected to partially buffer the decline in the aerospace division. Still, we expect a 10% fall in net profit for 2009 and for earnings to rebound in 2010 on the back of higher aerospace contributions from China, as well as further milestone contributions from the electronics and land system divisions.