SATS - UOB Kay Hian 2016-05-24: 4QFY16 Earnings Below Street Estimates On Higher Staff Cost And Weaker Pricing; Downgrade To HOLD

SATS - UOB Kay Hian 2016-05-24: 4QFY16: Earnings Below Street Estimates On Higher Staff Cost And Weaker Pricing; Downgrade To HOLD SATS LTD S58.SI 

SATS (SATS SP) - 4QFY16: Earnings Below Street Estimates On Higher Staff Cost And Weaker Pricing; Downgrade To HOLD

  • In 4QFY16, SATS was affected by a sharp rise in staff cost and weaker pricing. This led to lower-than-expected operating leverage. 
  • As staff cost rose 3% despite a 3% decline in revenue in FY16, the market is unlikely to re-rate the stock upwards until SATS demonstrates improved pricing or higher operating leverage. 
  • Along with a potential lower dividend payout ratio, share price upside will likely be limited in the near term. 
  • Downgrade to HOLD. Target price: S$4.20. Suggested entry price: S$3.60.



RESULTS 


Earnings below expectations on higher-than-expected staff cost. 

  • SATS' 4QFY16 net profit came in 8% and 13% lower than consensus and our estimates respectively. The deviation from our estimate was due to higher-than-expected staff cost (+10% yoy) and a decline in associate and JV contributions. 
  • 4QFY16 net profit also included a S$2.1m impairment on PPE due to fair value adjustments of non-core assets in Japan. 
  • SATS declared a final dividend of 10 S cents (FY15: 9 S cents). Payout ratio amounted to 75.4%, 4ppt lower than FY15’s.

SATS attributed the higher staff cost to “higher accrual of staff expenses and contract services” and seasonality swings. 

  • In FY16, staff cost rose 3% yoy, mainly due to wage pressures. SATS indicated that staff headcount in FY16 was flat yoy and staff productivity improved even taking into account wage increases.

SATS was also affected by unfavourable product mix which led to lower ASPs. 

  • Gateway services ASP fell 7% in 4QFY16 while food solutions ASP also declined yoy. SATS attributed this to a higher proportion of lower-value services with the resumption of the JetStar Asia contract. This led to gateway services revenue rising only 6% on the back of a 14.5% increase in unit services. Similarly, the growth in in-flight catering revenue excluding TFK was lower than the 5% rise in unit meals due to lower prices. Meanwhile, SATS indicated that pricing on full-service carriers held up, which is encouraging.

TFK yet to be profitable but management is optimistic of improving operations. 

  • Excluding the deconsolidation of the food distribution business to SBRF, food solutions revenue would have risen 6.7% yoy in 4QFY16. SATS attributed the organic revenue growth at the food solutions segment to the 19% yoy rise in TFK’s revenue on the back of higher volumes from the Delta Airlines contract.

Associate and JV contribution declined 11% yoy. 

  • The bulk of the decline resulted from a S$1.2m fall in food solutions contribution. SATS indicated that profits were affected by weaker regional currencies. 
  • In addition, profitability of AAT, the cargo associate in Hong Kong, also fell due to excess capacity and intense competition. However, SATS opined that it remains confident of the business’s long-term prospects due to its established reputation for service quality and connectivity to SATS’ cargo network.

Cash flow remained strong, with operating cash flow (OCF) and FCF rising 15.5% and 27% yoy respectively in FY16. 

  • Meanwhile, dividends from associates fell 62% yoy in FY16 but this was due to a one-off return of capital in FY15. Payout of associates amounted to 70%.



STOCK IMPACT


Operating leverage impacted by weak pricing and higher labour cost. 

  • In FY16, staff cost rose 3.2% despite a 3.1% decline in revenue. This shows that SATS faces significant wage pressures and its ability to curtail labour costs is limited. 
  • Along with weaker pricing on low-cost carrier services, this led to lower-than-expected operating leverage. Until SATS demonstrates improved pricing or higher operating leverage, the market is unlikely to re-rate the stock upwards.

SATS yet to benefit from increased scale at TFK. 

  • Despite the incremental volumes and the 19% rise in TFK’s revenue, the unit did not contribute to bottom-line. We believe the market will be disappointed as the revenue growth with the additional scale from the S$325m Delta Airline contract did not result in profit growth.

The potential for lower dividend payout, along with increasing capex, would limit stock upside in the near term. 

  • Meanwhile, SATS did not guide for payout ratio to be restored to the previous years’ levels. 
  • In addition, SATS also indicated that the JV with Wilmar would require additional capex of US$30m per kitchen facility with the first to be built in 12 months’ time. 
  • Given the additional capex in the next few years, dividend payout is likely to be lower and this would limit share price upside in the near term. We have thus assumed lower payout ratio of 78% each in FY17 and FY18.



EARNINGS REVISION/RISK

  • We lower our FY17 and FY18 core net profit estimates by 3.2% and 3.9% respectively after factoring in higher staff cost. 
  • We have also assumed S$9.2m in gains from the sale of 22 Senoko Way would be recognised in FY17. 
  • We also raise our capex forecasts for FY17 and FY18 by S$25m each after factoring in SATS’ contribution for the building of manufacturing facilities for the Wilmar JV.



VALUATION/RECOMMENDATION

  • Downgrade to HOLD with a lower target price of S$4.20. 
  • We continue to value SATS on a DDM basis (required return: 6.5%, terminal growth rate: 1.6%). 
  • We have assumed lower payout ratio of 78% in FY17-19 (previously 80%), following the reduced payout ratio in FY16. Suggested entry price: S$3.60. 
  • Our fair value of S$4.20 implies a FY17 dividend yield of 4.0%. We prefer STE (STE SP/BUY/S$3.50) which offers a 2016F dividend yield of 4.3%.



SHARE PRICE CATALYST

  • Lower staff cost, improved profitability at TFK and higher ASPs.





K Ajith UOB Kay Hian | Sophie Leong UOB Kay Hian | http://research.uobkayhian.com/ 2016-05-24
UOB Kay Hian SGX Stock Analyst Report HOLD Downgrade BUY 4.20 Down 4.50


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