SATS - UOB Kay Hian 2016-11-30: Strong Long-term Growth Prospects But Positives Priced In

SATS LTD S58.SI

SATS (SATS SP) - Strong Long-term Growth Prospects But Positives Priced In

SATS has outperformed the STI by 24% ytd (2015: +40%) due to its ability to generate ROIC at above its cost of capital, strong cash generation and strong balance sheet relative to other industrials.
Going forward, the stock is likely to market-perform as most of the positives have been priced in.

Future outperformance will likely be driven by stronger-than-expected throughput growth at Changi and earnings growth from JVs and associates.
Maintain HOLD. Target price: S$4.50. Entry price: S$4.25.

SATS expects increased automation and T4's additional capacity to facilitate growth. However, we do not expect T4 to immediately boost margins as part of the capacity will be moved from existing terminals. There is also the possibility of higher fee structure upon completion of T4, along with the removal of licensing fee rebates.
We are also less confident of throughput growth as the region is already grappling with overcapacity, weak loads and yields. At best, we expect T4’s FAST initiatives such as self-check and baggage drop could slow the pace of increase in staff costs. The Civil Aviation Authority of Singapore (CAAS) had stated that some 2,000 passenger service agents will benefit from job redesign and “enlargement efforts”.

The bulk of SATS’ overseas expansion is focused towards Indonesia and North Asia, markets which have long-term growth prospects. However, SATS has also made inroads into the Middle East via cargo handling JVs in Oman and Saudi Arabia, and will focus on handling high value-added items such as perishables and pharmaceuticals. The region has one of the fastest growing air cargo traffic, particularly on North America and European routes.
Management is also optimistic of its JV with Wilmar to provide high quality and safe food. We believe the JV has substantial long-term potential as Wilmar is already the market leader for consumer pack edible oil in China. Wilmar has an existing network of more than 8,000 distributors in China and SATS will be able to tap into Wilmar’s network and reputation. SATS will be building a kitchen in Shanghai, which will be operational next year.

SATS highlighted its recent investments in its duty-free JV with DFASS and an e-commerce air hub with Singpost. The former has commenced distribution of duty-free products on board SIA flights and SATS intends to expand via new airline partners. SATS also intends to tap on e-commerce growth via its airmail handling business with Singpost and could expand into other cities via similar JVs.
While these initiatives are still in early stages, we believe SATS is attempting to diversify and tap into new areas of growth.

SATS’ ability to generate ROIC in excess of its cost of capital was one of the key reasons for its outperformance vs the STI over the past two years. We expect the firm to generate a ROIC of 14% in FY17.
SATS is also re-investing capital into its JVs and associates as well as increase automation in an effort to reduce the reliance on labour. We believe this could boost operating efficiencies and drive growth over the long term. For FY17, we estimate SATS will re-invest S$73m in capital into its business.

Based on our regression analysis of P/B vs ROE (R square=0.86), SATS is trading at a 6% premium to peers’ P/B. Given that SATS is un-levered vs peers’ average net gearing of 61%, we believe the valuation premium is justified and likely to persist, especially in an environment of rising interest rates.
SATS also indicated that dividend payout will be dependent on net profit growth rather than cash flow.
For FY17, we expect SATS will pay out 18 S cents, or 82% of net profit, which implies a dividend yield of 3.8%. However, SATS could be more generous and return excess capital to shareholders.

The outperformance can be attributed to SATS’ strong cash generation and strong balance sheet, relative to other industrials which have higher gearing.
Future outperformance will likely be driven by stronger-than-expected throughput growth at Changi and earnings growth from JVs and associates.
On balance, we believe SATS is likely to market-perform as most of the positives have been priced in. Its strong balance sheet will continue to draw interest even amid relatively lower dividend yield.

Maintain HOLD and target price of S$4.50.
We continue to value SATS on a DDM basis (required return: 6.5%, terminal growth rate: 1.5%). At current levels, the market is implying a terminal growth rate of 1.9%.
We believe this is fair, given its new associates/JVs are unlikely to contribute substantially to earnings in the near term.
Suggested entry level is S$4.25.

K Ajith UOB Kay Hian | Sophie Leong UOB Kay Hian | http://research.uobkayhian.com/ 2016-11-30

UOB Kay Hian SGX Stock Analyst Report HOLD Maintain HOLD 4.500 Same 4.500