SATS (SATS SP) - UOB Kay Hian 2017-07-24: 1QFY18 Core Earnings Rise On Stronger Associate And JV Profits

SATS (SATS SP) - UOB Kay Hian 2017-07-24: 1QFY18 Core Earnings Rise On Stronger Associate And JV Profits SATS LTD. S58.SI

SATS (SATS SP) - 1QFY18 Core Earnings Rise On Stronger Associate And JV Profits

  • In 1QFY18, core net profit rose 3% yoy, driven by stronger associate and JV income.
  • At the operating level, operating profit declined due to higher licensing fees which were within expectations. Meanwhile, SATS demonstrated operating leverage as controllable costs fell 2.7% yoy, which led to higher margins for gateway services.
  • Going forward, we expect earnings to be driven by improved operating leverage and growth at associates and JVs. 
  • Maintain HOLD with a higher target price of S$5.10.



RESULTS


Earnings within expectations. 

  • Top-line growth was flat with gateway services revenue offsetting the decline in food solutions revenue. Meanwhile, core net profit growth was aided by higher gateway associates’ contribution. 
  • Operating profit declined by 2%, mainly due to a 25% increase in Changi airport's licensing fees, due to a cessation of rebates. Excluding this, operating profit would have increased by 6% yoy. We had already assumed the same for FY18, as would have the street.

Positive operating leverage from gateway services. 

  • Much of the increase in revenue for the segment was due to higher cargo handled and flight movements. Despite that, overall staff cost was flat yoy and SATS indicated this was due to positive operating leverage from increased automation for the segment. 
  • Controllable costs (opex excluding licensing fees and D&A) fell 3% yoy. Consequently, operating margins for the division improved, cushioning the decline in margins for the food solutions segment. 
  • Cost of raw materials declined by 7% during the period, but this would not have helped the in-flight catering business.

TFK was impacted by lower meal volumes as airlines cut flights due to overcapacity in Japan. 

  • Both Delta Airlines and Japan Airlines reduced capacity to Japan, which along with pricing pressures, led to the 11% decline in TFK’s revenue.

Meanwhile, local in-flight catering revenue was flat (+0.7% yoy) despite stronger throughput at Changi. 

  • SATS opined that pricing pressure was similar in Singapore and Japan, but the latter faces greater overcapacity issues. From 2QFY18 onwards, the JetStar Asia catering contract will start contributing and this should boost in-flight catering revenue. 
  • Meanwhile, non-aviation revenue at SFI also fell 1.2% yoy, due to an adjustment to major contracts.

Stronger performance by associates and JVs offset the decline at the operating level. 

  • The 27% rise in associate and JV income was led by an 89% rise in food solutions income. The latter was mainly due to contribution from new associate Evergreen Sky Catering (ESCC). However, excluding ESCC, SATS indicated that income from associates would have still risen due to growth from Indonesia, India and China.
  • Meanwhile, gateway services associate income rose 16% yoy, likely driven by higher cargo and flights handled at Indonesian associates PT Cas and PT Jas.

Excluding working capital, operating cash flow (OCF) was flat yoy (+0.1%), but FCF would have risen 1.5% due to lower capex. 

  • Meanwhile, dividends from associates declined, but the firm guided that this was primarily due to timing of recognition.


STOCK IMPACT


SATS exhibited good control within a difficult operating environment and a tight labour market. 

  • This was demonstrated by the fact that controllable costs fell by 2.7% even as revenue remained flat. We believe there is scope for further productivity improvements as SATS continues to invest in technology and automation. That said, we have factored in higher utilities costs in the coming quarters due to the recent hike in water tax. 
  • Overall, we are raising our earnings estimates for FY18, as we have assumed a reduction in opex. We also estimate that SATS will generate ROIC of 16% in FY18.

Earnings will be driven by improved operating leverage and overseas associates’ growth. 

  • While operating profit declined in 1QFY18, this was within expectations due to higher licensing fees following the end of rebates. Meanwhile, staff costs barely rose despite a 5% rise in gateway services revenue. This implies that SATS was able to achieve significant operating leverage for gateway services. Going forward, this will be one of the key drivers of growth. 
  • Meanwhile, SATS’ strategy of diversifying from reliance on Singapore is starting to pay off, with associates driving core earnings growth in 1QFY18. We believe the company’s long-term growth prospects remain intact. That said, valuations are fair at 23x FY18F PE and we prefer to be buyers at better entry levels closer to S$4.80. 


EARNINGS REVISION/RISK

  • We raise our FY18-19 net profit estimates by 5%, following stronger operating leverage as we expect continued growth at the gateway services segment which should boost margins. 
  • We have also assumed that the divestment of SATS-HK will be completed by mid-FY18 and this should lead to further cost savings.


VALUATION/RECOMMENDATION

  • Maintain HOLD but we raise our target price by 1% to S$5.10, following our revised earnings estimates. We continue to value the company on an EV/Invested Capital basis with WACC of 6.1% and growth rate of 3%. 
  • At our fair value, the stock will trade at 23x PE and offer a dividend yield of 3.6%


SHARE PRICE CATALYST

  • Lower staff costs, higher income from JVs and associates.




K Ajith UOB Kay Hian | Sophie Leong UOB Kay Hian | http://research.uobkayhian.com/ 2017-07-24
UOB Kay Hian SGX Stock Analyst Report HOLD Maintain HOLD 5.10 Up 5.050



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