SATS (SATS SP) - UOB Kay Hian 2017-09-28: Price Weakness Not Congruent With Positive Data Out Of Changi

SATS (SATS SP) - UOB Kay Hian 2017-09-28: Price Weakness Not Congruent With Positive Data Out Of Changi SATS LTD. S58.SI

SATS (SATS SP) - Price Weakness Not Congruent With Positive Data Out Of Changi

  • The recent decline in SATS' stock price is not congruent with positive data out of Changi, which shows 4.3% and 11% yoy increases in flight movements and cargo throughput respectively for Jul-Aug 17. If September’s data is equally strong, SATS 2QFY18’s revenue growth is likely to exceed 1Q’s. 
  • We are also not unduly worried about inflight catering revenue as SATS is likely to prevail if a pricing war continues. We also believe that pressure from airlines is likely to abate as yields stabilise.
  • Maintain BUY. Target price: S$5.40.



WHAT’S NEW


2QFY18 likely to show strong gateway services revenue. 

  • About 94% of SATS gateway services revenue accrues out of Singapore and that portion is highly correlated to flights and cargo handled at Changi. In 1QFY18, SATS gateway services rose 5.1% yoy, underpinned by 4.1% rise in flight movements and 7.4% rise in cargo throughput at Changi. 
  • Core operating profit, excluding the normalisation effect of Changi Airport’s licensing fees, rose 6% yoy, and SATS indicated that much of the growth was due to higher margins from the gateway services. 
  • Ytd, 2QFY18’s qtd (Jul-Aug 17) flight movements (+4.3%) and cargo throughput growth (+11%) is higher than 1QFY18’s and this holds scope for strong gateway services revenue and operating profit growth in the coming quarter.

Weak inflight catering pricing not a new phenomenon and is likely to stabilise.

  • Pricing on SATS inflight catered meals have been declining since FY14 and as such should have been factored in by the street. Local inflight catering revenue has risen by measly 0.5% CAGR from FY14-17. This was driven by aggressive competition between Dnata and SATs as well as pressure by airlines due to deteriorating yields. 
  • We also believe that airlines yield is likely to stabilise in the coming quarters (positively correlated with fuel prices) and with that, pressure on pricing will abate. 
  • We had also highlighted two weeks ago that the entry of Norwegian Air and Qantas into the Singapore market could lead to incremental inflight catering (and lounge catering for Qantas) and ground handling revenue in FY19. We still maintain this view.

SATS is 6x bigger than Dnata and will prevail. 

  • We believe that the street has not appreciated SAT’s superior scale for both catering and ground handling and its ability to prevail in the event that a pricing war continues. SATS also handles about 144,000 flights vs Dnata’s 40,000. Dnata’s CEO reportedly has stated SATS has been aggressively cutting prices and that this has impacted Dnata’s profits.

Operating leverage from cargo volumes and yields should not be underestimated.

  • With increased investment in automation, a significant part of marginal revenue increase from cargo handled will flow through to operating level. This is the main reason for 1QFY16’s 6% rise in core operating profit. 
  • We believe the next two quarters will see similar operating leverage due to seasonal demand. In addition, as cargo yields improve, there is a possibility that pricing on cargo handled could see a similar increase. As pointed out in our earlier note, this will not only impact SATS local operations but will also positively impact its associates.


STOCK IMPACT


Nowhere near ex-growth. 

  • We remain bullish on SATS, despite the 4.6% ytd decline in stock price. 
  • We also believe that the pullback is symbolic of a typical correction following the whopping 26% gain in 2016. Changi’s data points, as well good cost control, augurs well for SATS earnings. 
  • In the near term, the commencement of apron services to AirAsia in Jul 17 and catering services to Jetstar Asia in Aug 17 will boost 2QFY18 and 3QFY18’s earnings. 
  • Concurrently, increased automation at Changi for baggage and passenger handling will also reduce overheads. This is significant as in the past, SATS did not benefit from higher pax handled at Changi due to labour overheads. SATS’ attraction can also be gleaned from the fact that it generates substantially higher ROIC (16.5% in FY17) than most similar listed corporates, which justifies continued outperformance.


EARNINGS REVISION/RISK

  • There is no change to our earnings. However, there is likely to be a 3% increase in our earnings estimates for FY19, if SATs secures a contract from Qantas.


VALUATION/RECOMMENDATION

  • Maintain BUY with a target price of S$5.40. 
  • We continue to value the company on an EV/Invested capital basis with WACC of 6.1% and growth rate of 3.1%. At our fair value, the stock will trade at 23.5x PE and 18x ex-cash, while offering a dividend yield of 3.5%.


SHARE PRICE CATALYST

  • Announcement of contract awarded to SATS by Qantas.




K Ajith UOB Kay Hian | http://research.uobkayhian.com/ 2017-09-28
UOB Kay Hian SGX Stock Analyst Report BUY Maintain BUY 5.400 Same 5.400



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