We assess the stand-alone credit profile (SACP) of STE to be ‘aa’. In accordance with our criteria for government-related entities (GREs), our view of an extremely high likelihood of extraordinary government support is based on our assessment of the following STE characteristics:
-- Critical role as the sole domestic defense contractor and provider of repair and maintenance services to air, land, and marine military equipment and infrastructure.
-- Very strong link with its majority owner, the government of Singapore, through Temasek Holdings (Private) Limited (AAA/Stable/A-1+) and a special share held by Singapore’s Minister for Finance. The special share carries the right to approve any resolution to be passed by STE--either in the general meeting or by the company’s board of directors--on certain matters specified in the company’s Article of Association.
According to our GRE methodology, we would have to lower STE’s SACP by two notches or more to downgrade the company to below ‘AAA’, all other things remaining the same.
STE’s links to the government bolster its business position, with a monopoly in several key areas of national defense. Singapore’s Ministry of Defense is STE’s largest customer and we estimate that it has traditionally accounted for about a third of the company’s revenues. STE is expanding to commercial markets for higher growth and business diversification. As of June 30, 2012, STE’s order book is Singapore dollar (S$) 12.7 billion, its highest ever. The company is likely to deliver about S$2.5 billion during the second half of 2012. The strong order book offers stability and predictability to STE’s revenues and profitability over the next few years.
Given STE’s substantial international sales, significant fluctuations in the exchange rate of the Singapore dollar against the U.S. dollar and euro could affect the company’s performance. In particular, because STE incurs costs in Singapore dollar with respect to activities that generate U.S. dollars or euro revenue, an increase in the value of the Singapore dollar compared to the U.S. dollar or euro would negatively affect STE’s results. We believe that STE will maintain its conservative hedging policies.
STE is also exposed to potential earnings fluctuation from shipping and airline companies, to which it provides engineering, repair, and maintenance services. We believe STE can maintain earnings stability for one to two years given its strong order book. It has large and diversified customers. Also, its earnings risk is mitigated by the fact that the company requires letters of credit and advance payments from new customers or entities from high-risk geographic jurisdictions.
STE’s operating-lease-adjusted (OLA) debt was S$1.6 billion as of June 30, 2012, and we expect it to remain largely stable in the next couple of years. We net OLA debt with cash and short-term investments exceeding S$500 million (the minimum cash we estimate STE needs to operate), resulting in OLA debt of S$122 million as of June 30, 2012. This brings the ratio of OLA debt to EBITDA to 0.1x, from 0.7x a year ago. We expect the ratio to stay below 1.0x in the next one or two years. On the other hand, further increase in STE’s appetite for inorganic growth through acquisitions could affect the company’s financial strength, in our opinion.
STE’s liquidity is “exceptional,” as defined in our criteria. We expect the company’s liquidity sources to exceed uses by about 2x in 2012. Our liquidity assessment is based on the following factors and assumptions:
-- Key sources of liquidity include funds from operations (FFO) of about S$730 million in 2012.
-- Key uses of liquidity include our projected capital expenditure of about S$460 million.
-- STE’s cash and short-term investments of $1.98 billion as of June 30, 2012, are enough to cover debt due in one year of S$461 million.
The stable outlook factors in our expectation that STE will maintain its dominant and critical role in Singapore’s defense industry. The outlook also reflects our view that STE’s financial risk profile will remain strong enough to reduce potential pressure on the company’s profit margins due to intense competition in its growing overseas entities.
We could lower the rating on STE if Temasek Holdings’ ownership in the company falls below 50.1% or the special share held by the Minister for Finance is converted to an ordinary share. Both these events may signify weakening support from the Singapore government, and that would lead us to reassess our assumption that the government has a significant interest in ensuring STE’s financial health.
We could lower the rating if stiff competition and unfavorable exchange rates severely erode STE’s margin or the company adopts more aggressive financial policies for its growth initiatives. A downgrade trigger could be a weaker financial performance, including a debt-to-EBITDA ratio exceeding 1.5x on a sustained basis.
Related Criteria And Research
-- Enhanced Methodology And Assumptions For Rating Government-Related Entities, June 29, 2009
-- Key Credit Factors: Methodology And Assumptions On Risks In The Aerospace And Defense Industries, June 24, 2009
-- Criteria Methodology: Business Risk/Financial Risk Matrix Expanded, May 27, 2009
-- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008