SATS (SATS SP) - UOB Kay Hian 2017-08-02: Preferred Play On Strong Cargo Traffic And Stabilising Yields; Upgrade To BUY

SATS LTD. S58.SI

SATS (SATS SP) - Preferred Play On Strong Cargo Traffic And Stabilising Yields; Upgrade To BUY

We upgrade SATS to BUY and raise our target price by 6% to S$5.40 as we now assume higher revenue and margins following indications of stabilising yields and strong cargo volumes. The latter is expected to lead to greater operating leverage due to higher fixed costs.
We believe SATS is a better play on stabilising pax yields or higher cargo throughput as opposed to SIA given the latter’s exposure to volatile fuel costs.

SATS’ share price declined post 1QFY18 results and we believe this was due to concerns over pricing pressure for its inflight catering business due to weak airlines’ yields. However, this phenomenon is not new.
While SATS ceased to provide data on unit meals since 1QFY17, it is quite clear that pricing pressure is the key reason for low inflight catering revenue growth. This in turn has been blamed on airlines’ weak yields, especially from SIA. However, SIA’s pax yield has shown sequential improvement for two quarters, with yield declining just 1.9% in 1QFY18.
IATA also opined in July that pax yields have bottomed out. We are of the same view but assumed only a marginal yoy improvement for SIA and other regional full service carriers.

We now opine that SATS’ inflight catering ASP will at least stabilise in the coming quarters. Hence, we raise our inflight catering revenue assumption growth from 0.5% to 2.0% in FY18.
In FY17, the segment accounted for 28% of total revenue, growing just 0.3% yoy.

Global air cargo volumes have risen by high-single to double- digit yoy over the past four months and general consensus is for this trend to continue. Much of the growth has been driven by outbound Asia-Pacific air cargo to Europe and North America.
SATS’ gateway services revenue is highly correlated with cargo volume handled as well as flights handled. Hence, we raise our gateway services revenue growth estimate from 4.6% to 5.9%, excluding the deconsolidation impact from SATS HK. The latter is expected to be deconsolidated by mid-FY18.
In FY17, gateway services segment accounted for 43% of total revenue. Any increase in volume will have a greater impact on operating margins as SATS is increasingly automating its gateway operations.

In FY17, gateway associate income accounted for 79% of total associate income, excluding EI. Given expectations of strong cargo volumes, we now expect stronger contribution from the segment in FY18.

We highlight two catalysts for revenue and earnings growth - reduced pressure on in-flight catering and the likelihood of higher cargo volume. The latter is expected to lead to greater operating leverage due to higher fixed costs and relatively lower operating margins.
We now estimate SATS to generate ROIC of 17% in FY18.

While SIA generates higher operating leverage from improving pax yields, overall profitability is still dependent on a multitude of factors, including fuel costs, load factors, forex and capacity additions by competitors.
SATS has much better cash flow, lower capital commitments and will also be leveraged to higher cargo throughput, not just out of Singapore but also across North Asia.
On the food solutions segment, we have only assumed marginal improvement in pricing for the rest of the year and that too, only out of Singapore.

We raise our FY18-20 net profit estimates by 4-7% as we now assume higher revenue and margins following indications of stabilising yields and strong cargo volumes.

Upgrade to BUY and raise target price by 6% to S$5.40 (previously S$5.10) following our revised earnings estimates.
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 FY18F PE and 18x ex-cash, while offering a dividend yield of 3.5%

K Ajith UOB Kay Hian | Sophie Leong UOB Kay Hian | http://research.uobkayhian.com/ 2017-08-02

UOB Kay Hian SGX Stock Analyst Report BUY Upgrade HOLD 5.40 Up 5.100