SATS - DBS Research 2018-02-14: Growth Drivers Remain Intact

SATS - DBS Vickers 2018-02-14: Growth Drivers Remain Intact SATS LTD. S58.SI

SATS - Growth Drivers Remain Intact

  • Long-term growth drivers of Terminals 4 and 5 as well as productivity gains remain intact.
  • While partnership structure has not been finalised, its new flight kitchen in Turkey could be a potential share price driver. Existing Ataturk Airport handled more flights and passengers than Changi in 2017.
  • Maintain BUY; DCF- and PE-based Target Price rolled over to FY18F at S$5.67.

Maintain BUY, Target Price revised to S$5.67. 

  • We remain positive on the long-term prospects of SATS and are maintaining our BUY call, with a higher Target Price of S$5.67, giving a total potential upside of 12% including dividends. 
  • Long-term growth drivers stem from 
    1. passenger and air traffic growth at Changi Terminal 4;
    2. automation and staff productivity driving modest cost increase and better margins in the next few years;
    3. the development of a flight kitchen in Turkey; and
    4. the opening of Terminal 5.

Where we differ. 

  • We believe the development to set up the world’s largest flight kitchen in Turkey and Changi Terminal 5 will be positive key driver of the share price over the longer term.

Potential catalyst. 

  • While the structure of SATS’ partnership with Turkish Airlines has yet to be finalised, Istanbul New Airport, when fully completed, is expected to be the largest airport in the world, serving up to 150m passengers a year. This could add significantly to meal volumes and revenue, given that Istanbul’s Ataturk airport handled 44m international (19m domestic) passengers and over 300,000 international (143,000 domestic) aircraft movements in 2017, provided SATS has a substantial interest in the new business. 
  • Comparatively, Changi’s aircraft landings came in below 200,000 and had a passenger throughput of 62m in 2017.


Blended DCF and PE valuation methodology. 

  • Our Target Price is S$5.67, which is based on the average of discounted cash flow (DCF) valuation (7.6% weighted average cost of capital and 3% terminal growth assumption) and PE valuation pegged within peer average of 22x FY19F earnings.

Key Risks to Our View

  • Our earnings growth takes into account a recovering aviation outlook and better cost structure. Slower recovery in air traffic and failure to keep operating costs in check are key risks to our earnings and Target Price.

WHAT’S NEW - 3Q18 results 

3Q18 earnings in line: 

  • 3Q18 earnings of S$66m (+2.3% y-o-y) was within estimates. 
  • The quarter’s earnings were supported by stronger Associates & JV income, and exceptional gains of S$4.6m derived from a writeback of earn-out from associate MacroAsia, which did not meet its earn-out targets. Otherwise, headline earnings were dragged by slightly weaker operating margins and slightly higher taxes on a new subsidiary incorporated that has non- tax-deductible items.

Revenue flat: 

  • Revenue was relatively flat at S$440m (-0.2% y-o-y).
  • Food Solutions declined 2.4% y-o-y to S$240m, offset by Airport Services which grew 3.1% y-o-y to S$199m.
  • Passenger volumes at Changi grew 6.3% y-o-y for the quarter while cargo at Changi grew 7.3% y-o-y. Key decline in Food solution segment came from TFK (-3.5% y-o-y, S$60.5m) and aviation food (-3% y-o-y, S$117.7m). 
  • TFK saw Vietnam Airlines leaving for ANA’s flight kitchen due to their partnership, while aviation food suffered an accounting decline as loss-making SATS HK is now accounted for as an associate. 
  • SATS had divested its 51% stake in SATS HK to Hong Kong Airlines in March. Without the deconsolidation, revenue would have increased +1.3% y-o-y.

Opex remained flat. 

  • Opex was flat at S$374m, similar to 3Q17. An increase in licensing fees, depreciation charges, and other costs was offset by declines in staff costs, raw materials as well as company accommodation and utilities. There were higher licensing fees as Changi’s rebates ceased from 1Q18.
  • Other costs increased because of higher fuel costs and lower Changi rebates recognised in other costs. Depreciation was higher, in line with automation initiatives. As headline revenue declined vis-à-vis flat operating costs, operating margins in 3Q18 were consequently lower.

Higher associates and JV income. 

  • Associates and JV income grew 7.9% y-o-y to S$13.7m. while food solutions almost doubled to S$3.1m, Gateway services associates declined 4.5% y-o-y to S$10.6m. The drag was partially currency translation impact, and also due to the contribution of loss-making SATS HK this quarter.

Still early in the AirAsia partnership. 

  • SATS’ partnership with AirAsia commenced on 1 November, with the deal closing in early January. The contribution of this partnership remains undisclosed as the cooperation is in its early stages. However, we understand that there are operational startup costs at this stage. 
  • Ground Team Red’s numbers remain undisclosed as well. However, based on our AirAsia analyst’s estimates, AirAsia’s ground handling net profit is likely to be minimal at below RM20m. At c.49% stake, this works out to approximately S$3m contribution or only 1.2% of FY19F earnings or less.

In anticipation of traffic volumes in Turkey that could potentially contribute. 

  • SATS’ MOU with Turkish Airlines to operate one of the largest flight kitchens in the world remains under discussion. SATS will reveal more details in the subsequent months or when an agreement is signed. 
  • While no ownership structure of the cooperation has been disclosed, our positive stance for now is based on the new airport’s passenger and traffic statistics.

Istanbul New Airport will be the largest in the world. 

  • The current Istanbul Ataturk airport handled 63m passengers and over 300,000 international aircraft movements in 2017, higher than Changi’s sub-200,000 aircraft landings and 62m passenger throughput in 2017. The New Istanbul Airport is planned to handle 150m passengers a year, the largest airport in the world. 
  • With Turkish Airlines (as Turkey’s flag carrier that has over 400,000 international flights from Turkey) as partner, we expect SATS to benefit from meal volumes that will be forthcoming when the kitchen opens. As the airport’s initial phase is expected to open as soon as CY4Q18, the kitchen will not be up in time. 
  • An agreement on the partnership structure, financing, and construction of the flight kitchen will have to take place before SATS can commence operations.

What is SATS’ stake and the structure in this cooperation? 

  • For financial reference, THY DO & CO Ikram Hizmetleri A.S. a 50% owned subsidiary of DO & CO, which operates a flight kitchen at Istanbul’s Ataturk Airport reported revenue of €294m and earnings of €27m in FY17. 
  • While details of the deal structure and each party’s stake in the business remain undisclosed, we look forward to understanding what SATS’ interest and financial commitment is to this cooperation, amongst others, before we are able to assess a reasonable financial impact of this cooperation. 
  • Nonetheless we are positive on the meal volumes that this cooperation can potentially deliver.

Growth drivers remain intact. 

  • 3Q18 results are within estimates and our earnings projection remain largely unchanged. We stay positive on SATS as we believe longterm growth drivers remain intact. 
  • The opening of Terminal 4 will provide near-term potential for carriers to add more flights to Changi. Terminal 5 will double Changi’s capacity over the longer term, while the cooperation with Turkish Airways to operate one of the largest flight kitchens in the world at New Istanbul Airport will provide more meal volumes for SATS when the flight kitchen is completed.   

Maintain BUY, Target Price S$5.67. 

  • Our Target Price is based the average of 22x FY18F EPS (from FY17F previously) and DCF (7.6% weighted average cost of capital and 3% terminal growth assumption).
  • Our Target Price of S$5.67 implies a FY19F PE of 23x, within peer average. Maintain buy for 12% upside including dividends.

Alfie YEO DBS Vickers | Andy SIM CFA DBS Vickers | http://www.dbsvickers.com/ 2018-02-14
DBS Vickers SGX Stock Analyst Report BUY Maintain BUY 5.67 Up 5.020