SATS (SATS SP) - UOB Kay Hian 2017-05-22: 4QFY17 Long-term Growth Expected To Be Driven By JVs And Associates

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SATS LTD. S58.SI

SATS (SATS SP) - 4QFY17 Long-term Growth Expected To Be Driven By JVs And Associates

• SATS' 4QFY17 headline net profit included negative goodwill, excluding which earnings would have risen 1.7% yoy. 
• While valuations remain rich, we believe that the street will continue to appreciate SATS’ strong cash flow and ability to generate returns on capital. Thus we expect valuations to remain status quo, despite expectations of lower FY18 earnings. This is especially due to SATS ability to generate superior ROIC in contrast with other industrials. 
• Maintain HOLD with a higher target price of S$5.05.

RESULTS AND ANALYST BRIEFING TAKEAWAYS

Earnings slightly below expectations on higher costs. 

• Headline 4QFY16 net profit included S$15m in negative goodwill from the reclassification of 25%-owned Evergreen Sky Catering from long-term investment to an associate. Excluding this, core net profit rose 1.7% yoy, below our and street estimates of a 5% and 4.3% rise. The deviation from our estimate was due to: 
  1. higher-than-expected staff cost as SATS was affected by lower government subsidies and wage pressures, and 
  2. higher accommodation and utilities costs. 
• SATS declared a final dividend of 11 S cents (FY16: 10 S cents). Payout ratio amounted to 74% vs FY16’s 75.4%.

Excluding EI, food solutions associate profits rose 18% yoy, but SATS indicated this was primarily due to contribution from new associate Evergreen Sky. 

• Excluding the latter, food associate profits would have been largely flat yoy. 
• Still, Malaysian in-flight catering associate Brahim turned profitable in 4QFY17. Meanwhile, gateway associate profits rose 4% yoy.

Guided for lower operating margins in FY18, due to: 

1. higher licensing fees, 
2. wage cost pressures, and 
3. price pressures from airlines. 

• Following the end of Changi Airport rebates in Mar 17, SATS guided for a S$10m-15m impact from higher licensing fees, in line with our estimate of a S$11m-13m rise. 
• Management also expects higher staff costs over the new few quarters due to a reduction in government subsidies.

Local in-flight catering revenue was flat (+0.1% yoy) despite higher pax throughput growth at Changi. 

• This implies that pricing for meals fell yoy. SATS alluded to the tough operating environment for its airline customers, however demand for premium meals remains robust. 
• Meanwhile, TFK’s revenue fell marginally by 0.7% yoy, due to a slight dip in volumes. 
• For the full year, food solutions margins rose 0.9ppt to 17.1%, resulting in a 6% rise in operating profit on the back of a 0.6% top-line growth.

Gateway services segment was the main profit driver for FY17. 

• The segment’s margin rose 1ppt yoy to 7.5%. Combined with revenue growth, this led to a 19% rise in operating profit as the segment benefitted from increased economies of scale with the Jetstar Asia and AirAsia contracts.

Cash flow remained strong, with OCF margin improving 0.6ppt to 15.7%. 

• Excluding working capital, operating cash flow (OCF) rose 6% yoy. 
• Meanwhile, dividends from associates rose 24% yoy in FY17.

STOCK IMPACT

Diversifying into higher-growth markets; stay invested for long-term growth. 

• SATS generated ROIC of 17.3% (inclusive of dividends from associates) in FY17. 
• While we expect returns to decline over the next two years mainly due to higher costs at Singapore, we are heartened that SATS plans to diversify away from Singapore via strategic JVs.

Wilmar JV expected to breakeven in FY19. 

• The JV to supply safe and high quality food in China, has commenced operations in Kunshan in Mar 17 and acquired three customers thus far. 
• SATS intends to ramp up the JV in FY18 and indicated that the JV is on track for breakeven in FY19. 
• Other plans include new ventures into non-aviation food solutions businesses, while SATS also indicated that there is a possibility of partnering with airlines to establish kitchen bases. 
• Meanwhile, SATS’ guidance of lower operating margins in FY18 is within expectations and we have already factored in lower FY18 earnings due to higher licensing fees. 
• Going into FY19-20, we expect core earnings to pick up as costs normalise.

EARNINGS REVISION/RISK

• We raise our FY18 net profit estimate by 3.7%, following management’s guidance that the partial divestment of SATS HK and AAT will be completed in 1HFY18. 
• We have also assumed higher staff costs. We expect FY18 core net profit to decline 5% yoy, and earnings to recover in FY19 subsequently.

VALUATION/RECOMMENDATION

• Maintain HOLD with a higher target price of S$5.05. 
• We had valued SATS on a DDM basis previously, however, we now value the company on an EV/Invested Capital, which takes into account the return on invested capital along with the cost of capital. 
• At our fair value, the stock will trade at 24x PE and offer a dividend yield of 3.6%. 
• Suggested entry level is S$4.75.

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/ 2017-05-22

UOB Kay Hian SGX Stock Analyst Report HOLD Maintain HOLD 5.05 Up 4.600