SATS (SATS SP) - UOB Kay Hian 2017-11-30: Key Takeaways From Luncheon

SATS LTD. S58.SI

SATS (SATS SP) - Key Takeaways From Luncheon

We hosted a luncheon for clients and came away impressed with SATS’ long-term plans.
The bulk of clients’ queries centered on the rationale behind the formation of a JV with AirAsia in Malaysia and prospects for growth via the partnership with Turkish Airways. Clients were also concerned as to whether the new investments could dilute returns. However, SATS maintained that future growth will be underpinned by JVs and associates.
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We hosted a luncheon presentation with SATS for clients. Key takeaways are as follows:

SATS’s CFO, Manfred Seah, stated that the group is very much focused on the dual pillars of food solutions and gateway services and seeks to build scale and connectivity within Asia which will have the fastest growing aviation market and extensive food requirements.
Citing the example of the investment in Turkey, SATS indicated that Turkish Airlines has limited connectivity within Asia and that as connectivity improves, SATS could leverage on this via its own exposure in Singapore, Malaysia, Maldives, Taiwan, Philippines, Indonesia, India, Hong Kong and China.

SATS indicated that they are partnering with the leading LCC in Asia and this will give them scale in Malaysia, as AirAsia accounts for a third of Malaysia’s seat capacity across 16 airports. However, our analysis shows that if AirAsia’s associates are taken into account, (which is part of the JV agreement) the group will have a share of almost 50% seat capacity out of Malaysia.
The JV will also be targeting third-party ground handling works and SATS will have operational control of the JV.
At Singapore’s T4, SATs will retain a 60% effective stake in the ground handling JV. SATS also indicated that the AirAsia group accounted for approximately 50% of the current seat capacity out of T4 and thus was seen as a logical partner.

Taking into context that current ROE approximates 17%, there was concern among clients that regional expansion could dilute overall ROE. SATS indicated that expansion takes into account cost of capital, rather than ROE and that they place a higher hurdle rate for overseas operations compared to domestic operations.
SATS declined to provide details on the hurdle rate, but noted that sustainable return on capital could be lower than current returns.

SATS again indicated that the new Istanbul airport and the kitchen will be the world’s largest if the deal goes through. Turkish Airways will have a 50 % share in the JV. Presently, Turkish Airways accounts for 70% of pax throughput out of Atartuk airport and will thus be a major customer. Vienna-based DO&Co is the current caterer at Atartuk and we estimate that Turkish Airways’ in-flight catering revenue out of Atartuk could account for 30% of its revenue. Based on that, the JV could boost SATS’ inflight catering revenue by about 25% on a consolidated basis.
Impact to bottom line, will depend on SATS’ ability to achieve cost efficiency. Notably, DO&Co’s EBIT margin is approximately half of SAT’s in-flight catering revenue out of Singapore and Japan. (SATS’ in-flight catering margin is estimated to be higher than food solutions’ margin).

Rising e-commerce transactions in Asia should lead to higher air cargo throughput, benefitting SATS and its associates. Higher value-added cargo such as pharmaceuticals should also boost margins, though SATS indicated the primary earnings driver will still be volume growth.

SATS’ 28%-owned, Beijing Airport In-flight Kitchen (BAIK) and Beijing Ground Services (BGS) will operate at the new airport in 2019. We believe there will be a significant boost to earnings as both BAIK and BGS could secure catering and ground handling contracts from China Southern Airlines and China Eastern Airlines. Both carriers plan to establish Daxing as a hub and operate on international routes to Europe and the US.

We believe that SATS is well-positioned for long-term growth.
While ROIC on overseas projects are likely to be lower than that from local operations, we still expect returns to be above the cost of capital and thus deem the expansion plans to be accretive.

We have valued SATS on a sustainable ROIC of 16% (estimated 17.5% for 2018) and a WACC of 6.2% and growth rate of 3.3%. At our fair value, the stock will trade at 24.6x 2018F PE and an ex-cash PE of 23x.

K Ajith UOB Kay Hian | http://research.uobkayhian.com/ 2017-11-30

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