SATS (SATS SP) - 3QFY17: Boosted By Higher Cargo Volumes, But Earnings Likely To Moderate
- 3QFY17 earnings were slightly better than expected due to a boost in cargo volumes following the Hanjin bankruptcy. However, FY17 is likely to be the peak earnings period for the next two years, unless JVs surprise on the upside.
- We believe the street has fully factored in most of the positives from cost control, and SATS’ ability to generate positive jaws in coming quarters will be challenged, given the high base and the likely normalisation of cargo volumes.
- Continue to top-slice. Maintain HOLD.
- Target price: S$4.60. Suggested entry price is S$4.30.
Earnings marginally better than expected as SATS benefitted from higher cargo volumes.
- The 7% earnings growth was achieved on the back of positive jaws from the gateways services unit as well as gateway services associates. Both divisions benefitted from the disruption to the sea freight caused by the Hanjin bankruptcy which led to a modal shift to air cargo, particularly for express freight. Beneficiaries were SATS’ Singapore gateway operations, SATS-HK, AAT and PT JAS.
- Gateway services revenue however rose at a slower rate than Changi flight movements’ growth of 3.7% as the inclusion of apron services for AirAsia would have reduced unit gateway revenue.
- Food solutions revenue decline attributed to flat in-flight catering revenue, the deconsolidation effect on SATS-BRF and the recognition of institutional catering major event in 2QFY17. On a 9MFY17 basis, food solutions revenue remained flat yoy, with TFK’s 24% growth offsetting the decline at SATS-BRF and flat in-flight catering revenue.
- Operating costs rose at a faster rate (+1.3%) than revenue, mainly due to higher staff costs (+1.2%) and D&A (+2.8%). Staff cost growth in 3QFY17 was however noticeably slower than the preceding 1HFY17’s 5.9%, partly due to the inclusion of additional headcount in the preceding quarters. SATS indicated that it remains a challenge to manage staff costs at a run-rate below inflation and stated that ongoing investments in automation would eventually lead to lower headcount. SATS also indicated that the opening of T4 in late-17 will only lead to about S$3m increase in opex.
- Raw material costs declined by 8% yoy and the weaker S$ did not lead to higher costs as feared. This was because SATS sources raw material from various countries and locks in prices up to two years in advance, thus allowing SATS to lock in input costs well in advance.
- Operating cash flow (OCF) excluding working capital changes rose 10% yoy to S$209m in 9MFY17. However, a steep increase in capex led to a 5% decline in FCF.
- Meanwhile, SATS generated a 16% OCF margin on revenue.
Does not expect further increase in operating margin; pricing environment remains challenging for the aviation business.
- SATS was pessimistic on airlines’ operating conditions and does not foresee an improvement in pricing for either catering or gateway operations. SATS opined that any operating leverage will have to arise from increased automation.
- SATS expects overseas JVs to grow at a faster rate than Singapore operations over the long haul. SATS’ JV with DFASS to provide duty-free products at Marina Bay Cruise Centre and on flights was said to be already profitable.
- Meanwhile, SATS indicated that the Wilmar JV will start production at the end of 4QFY17. We have assumed marginal contribution of S$4m from the JV in FY18.
- We raise our FY17 net profit estimate slightly by 2.5% as we factor in higher gateway solutions revenue from cargo operations and lower raw material costs.
- We also lower our FY18 earnings estimates by 8% after factoring in slower TFK revenue growth and higher staff costs.
- FY17 is likely to be the peak earnings period for possibly the next two years, unless the recent JVs surprise on the upside. We believe the street has fully factored in most of the positives from automation-related cost control. However, the revenue environment remains challenging.
- We also believe that SATS’ ability to generate positive jaws in the next few quarters will be challenged, given the high base in FY17, and the likely normalisation of air cargo volume.
- We roll forward our valuations to FY18 and derive a higher target price of S$4.60 (previously S$4.50). We continue to value SATS on a DDM basis (required return: 6.3%, g: 1.3%). Our target price implies a FY18 PE of 23x and FY18 dividend yield of 3.5%.
- Suggested entry price is S$4.30 for a 10% total return inclusive of dividends.
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- Improving margins and ASP.