SATS (SATS SP) - Maybank Kim Eng 2017-05-22: 4Q17 A Miss But Outlook Better

SATS (SATS SP) - Maybank Kim Eng 2017-05-22: 4Q17 A Miss But Outlook Better SATS LTD. S58.SI

SATS (SATS SP) - 4Q17 A Miss But Outlook Better

Upgrade to HOLD 

  • While reported 4Q17 PATMI of SGD66.6m was in line with our (and street) forecasts, it included a one-off SGD15m, excluding which the results were lower than expected. But importantly we are encouraged by the progress seen in various initiatives and new investments. 
  • We revise our FY18/FY19 profit forecasts +5.5%/8.3% and TP to SGD4.90 from SGD3.76 based now on 19.8x, +1sd over 5y mean (vs. 17x before) FY19 EPS on expectation of further 150-200bps ROE improvement in the medium term. 
  • Upgrade to HOLD.

4Q17 miss from softer Food Solutions, higher costs 

  • The main reasons for the 4Q17 core profit miss were softer Food Solutions revenue which grew 0.7% YoY (vs. our c2.5%) and higher staff cost which grew 2.2% YoY (vs. our flattish estimate). 
  • However we expect investments in technology and productivity over the past 18 months to yield results that should see staff related costs grow at a slower pace compared to revenues on a sustained basis. 
  • Our FY18/FY19 revenue outlook is unchanged and the upward profit forecast revisions are largely to do with revisiting cost structure assumptions.

Positive momentum in some key new ventures 

  • Various developments in the quarter suggest declining execution risk in new investments and a focus on tackling problem entities in the network. 
  • Management stated that the first commercial kitchen in China for SATS Yihai Kerry had started operations on schedule in March and take-up from initial three customers was encouraging. 
  • Brahim’s inflight catering in Malaysia had turned the corner to post a profit. Also the entry of Hong Kong Airlines as a shareholder in Asia Airfreight Terminal would address the problem of a lack of base-load cargo volumes for the entity.

Upgrade to HOLD with revised TP of SGD4.90 

  • We have changed our TP valuation multiple from using a 5y forward mean PE (17x) to a +1sd premium over the 5y forward mean PE, a premium we ascribe due to growing confidence in new ventures delivering and ROE enhancement by c150-200bps. 
  • Key upside risk lies in better traffic growth and downside risk in execution in new ventures.

Results highlights 

4Q17 comments and briefing takeaways 

  • 4Q17 reported PATMI of SGD66.6m was in line with our and street expectations. However the quarter included a one-off SGD15m negative goodwill charge in relation to an increased stake in Evergreen Sky Catering Corp. in Taiwan from 15% to 25%. This entity is now an associate (was classified as a long term investment earlier).
  • Excluding this one-off 4Q17 profit was lower than our expectation with the miss coming from softer Food Solutions revenue and slightly higher than expected staff costs.
  • Group operating metrics in 4Q17 were good – passengers increased +3.5% YoY, flights handled +4.1%, cargo processed +7.3% and ships handled +31.6%. Gross meals declined slightly by 0.4%, we presume in part due to a growing proportion of low cost carrier flights in the mix.
  • TFK in Japan saw a small decline in revenues by 0.7% in the quarter from a lower absolute number of meals served combined with currency translation impact. Singapore revenues grew 2.8% in the quarter.
  • Key developments amongst the relatively new investments were a turnaround to profitability for Brahim’s inflight catering in Malaysia and the commencement of commercial operations on schedule for SATS Yihai Kerry in China.
  • The restructuring of shareholdings in Asia Airfreight Terminal in Hong Kong with the entry of Hong Kong Airlines as a major shareholder is a big positive for the entity. In the past, a lack of any airline-affiliation or shareholding had been a stumbling block to getting base-load cargo volumes for the terminal.
  • Management sees opportunities in perishable cargo transhipment growth (from Australia to EU) given that SATS’ Coolport facility for handling food and pharmaceutical products has just been certified by the European Union (the first in the region).

Summary of forecast changes 

  • We have revised our FY18 and FY19 net profit forecasts by +5.5% and +8.3% respectively. We also introduce our FY20 forecasts.
  • Our FY18/FY19 revenue outlook is unchanged The key underlying drivers behind the changes are largely to do with revisiting our cost structure assumptions particularly for staff, lease and other operating costs in light of the on-going productivity related investments being made by the company which management says are beginning to show results.

Valuation and risks 

  • We have changed our target price valuation multiple from using a 5y forward mean PE (17x) to a +1sd premium over the 5y forward mean PE.
  • We believe this premium is justified due to our growing confidence in new ventures delivering over the next 3-5 years which will be instrumental in diversifying away from the cyclical aviation business which still accounts for c80% of the company’s revenues.
  • ROE’s have been recovering over the last two years to pre-GFC levels. While industry competition has intensified, the various productivity enhancing measures along with growth in the non-aviation business suggest to us there is room for another 150-200bps ROE improvement over the 3-5 year medium term.
  • SATS is currently trading at +2sd above its 5y mean PE.

Risk factors 

Upside risks: 

  • The key upside risk factors to our rating and valuation are a positive change to the current competitive environment and an improvement in fundamentals for the airline industry that could improve pricing dynamics for the aviation services industry, transformational inorganic growth from acquisitions and higher dividend payout (currently capped at around 80% levels despite large cash hoard) 

Downside risks: 

  • The key downside risk factors lie in a deterioration in the airline industry fundaments and in execution risk with the various new ventures/investments. 
  • While the progress is encouraging in some of these ventures, payback periods are long for most and poor execution that results in a drag to profits from the core legacy business would be a negative.

Neel Sinha Maybank Kim Eng | http://www.maybank-ke.com.sg/ 2017-05-22
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