SATS (SATS SP) - Maybank Kim Eng 2018-02-14: Awaiting The Growth Slipstream

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SATS LTD. S58.SI

SATS (SATS SP) - Awaiting The Growth Slipstream

3Q/9M FY18 delivered despite cost pressures 

• SATS' 3Q/9MFY18 results were in line with our expectations (and the street’s too, we believe) with 3Q PATMI up 2.3% y-o-y in the face of cost pressures this year. 
• Going forward, we expect profit growth to accelerate in FY19- FY20E, buoyed by contribution from new ventures and continued productivity initiatives. 
• We raised our P/E-based Target Price by 7% to SGD6.10 from rolling forward to end-FY20 EPS (mid-FY20 previously) on a multiple of 21x (unchanged), equal to 1SD over 5y mean. Maintain BUY.

Associates, cost control underpinning modest growth 

• 3Q18 revenues were flat y-o-y and the modest 2.3% PATMI growth was principally derived from a combination of a tight rein on operating costs and associate/JV profit growth of 7.9%. As previously guided by management, FY18 is expected to be a challenging year given the anticipated cost pressures emanating from increases in Changi Airport licence fees, expiration of Changi Airport incentives, start-up expenses in new ventures that have yet to materially contribute, as well as rising fuel prices. 
• We expect the base effect of these various factors on growth should ease going into FY19.

Japan remains the key area of disappointment 

• TFK Japan 3Q18 revenues declined 3.5% y-o-y (in contrast, Narita Airport international passengers grew 5.2% y-o-y in the quarter; Haneda Airport statistics not available yet). TFK’s revenue decline was even steeper at 9.5% y-o-y for 9M18. Management attribute part of this decline to loss of volumes from Vietnam Airlines (who have recently partnered with ANA) and Delta Airlines, which has reduced the number of flights ‘hubbing’ through Japan. 
• SATS is looking at various options to improve utilisation and possibly streamline costs further.

Diverse pipeline of new ventures in the wings 

• We are bullish about SATS’ growth outlook for FY19-FY20E from a number of investments with attractive growth potential made in the past couple of years (key ones detailed inside). 
• In addition, there is organic growth potential in Singapore from the recently opened Changi Airport Terminal 4 and continued productivity improvements that it is investing in.

3Q/9M FY18 results highlights: 

• SATS' 3Q18 results were broadly in line with our expectations. Revenues undershot our estimates by some c4% but this was compensated by better-than-expected cost control (flat y-o-y for both 3Q18 and 9M18), and reported PATMI accounted for around 75% of our full-year forecast.
• We expect the results would have been broadly in line with the street too as our FY18E profit forecast is close to the consensus average.
• There were three factors that distorted y-o-y comparison of a few specific line items somewhat:
  1. SATS Hong Kong was deconsolidated post its ownership restructuring in mid-2017, which lowered revenue growth (management indicated revenues would have grown 1.3% in 3Q18 without this deconsolidation),
  2. Associate & JV profit contribution was depressed with the inclusion of SATS Hong Kong (as the entity is currently loss making); and
  3. the effective tax rate for the quarter was higher than normal due to some start-up losses in its ventures that that did not qualify for tax exemption.
• Depreciation and amortisation increased c7% y-o-y from on-going investments to improve productivity and automation. These investments will continue and SATS expects capex (ex-new ventures) at cSGD100m levels annually, around 10-12% higher than in FY17.
• Associate & JV profit grew 7.9% y-o-y from a combination of Food Solutions profit contribution almost doubling (driven by Indonesia, India, Philippines ventures in our view) and Gateway Services declining 4.5% (after incorporating SATS Hong Kong).
• Management indicated it’s still looking to invest in new markets as well as non-aviation segments while also reiterating its aim to deliver sustainable and progressive growth in dividends to shareholders.

Confluence of new drivers over next two years 

• We expect a number of growth factors to fall in place for SATS in FY19 -FY20E from investments and foray into new ventures made over the past couple of years , as well as on-going productivity improvement initiatives. 
• Some of the key ones are: 

MOA for exclusive in-flight catering services for Turkish Airlines (THY; Unlisted) international flights and others at the Istanbul New Airport: 

• In our view, this is potentially the venture with the largest growth potential. The airport is under construction and reportedly expected to be inaugurated in late 2018 with the first phase expected to have a passenger capacity of 90m and when fully completed around 2030 is expected to be the largest in the world with a capacity of around 150m. 
• SATS envisages that if the transaction goes through, the flight kitchen would likely be amongst the largest in the world. 
• As of last reported FYE 2016, THY carried 35.5m international passengers operational (to put in perspective, around 12% more than Singapore Airlines (SIA SP; SGD10.62; Target Price SGD10.95; Hold) for FYE Mar -2017).

Ground handling JV with Air AirAsia (AIRA MK; MYR4.23; Target Price MYR3.90; Hold): 

• The venture commenced operations in Nov -2017 with final details of the deal formalised in Jan -2018. Passenger traffic in Malaysia has been growing at high single digit to low double digit levels since 2011 and for SATS the immediate opportunity lies in airports , like KLIA, Penang, Kuching and Kota Kinabalu that have both high traffic throughput and where AIRA is amongst the leading operators in terms of flight frequency. 
• The JV can also competitively target other airlines that do not have adequate economies of scale at potential customers at these airports. 
• Over the longer term it plans to explore gateway services opportunities in several regional markets like Thailand and the Philippines where SATS does not have material ground handling presence.

Qantas (QAN AU; Not -Rated) moving its connecting hub for UK flights back to Singapore: 

• After a hiatus of five years, Qantas, an existing customer, is moving its hub for UK bound flights back from the Middle East to Singapore commencing Mar -2018. This should be incrementally positive for SATS ground handling and in -flight catering volumes.

JV with DFASS tapping on travel retail spend : 

• This venture with Singapore’s Duty Free licensee allows SATS to tap on the growth potential for inflight duty -free and duty -paid sales, mail order service and ground -based duty free and duty -paid retail sales in Singapore.
• Importantly , it leverages on SATS ’ existing capabilities and assets in providing inflight services that involve bar-cart packing, warehousing and cabin loading and will entail minimum new investments in capex and capabilities.

SATS Yihai Kerry JVs ramping up: 

• This is one of the key non -aviation related new ventures. It operates a large -scale commercial kitchen in China . Its first kitchen is reportedly ramping up well with c18 -20 customers already on board since commencing operations mid-2017. Construction for the second is in the planning stage.

Outlook for Brahims Airline Catering improving: 

• While this late -2015 investment had a slow start in generating returns given its largest customer Malaysian Airlines (MAS; Unlisted) was undergoing financial restructuring, management indicate d that the venture has been profitable for the past few quarters and, importantly, the outlook for inflight meal volumes is looking up.

Expected turnaround of SATS Hong Kong: 

• The restructuring of SATS Hong Kong in mid-2017 with the entry of Hong Kong Airlines as a majority strategic shareholder with 51% stake is a key development towards a turnaround in profitability. The key structural challenge faced by the entity was being the newest of the three air cargo facilities at Hong Kong International Airport without an airline affiliation to provide base load cargo volumes. This problem has effectively been addressed by the ownership restructuring, in our view. 
• We expect current losses to decline in the coming quarters and the entity to be profitable in FY20.

Cargo facilities investment in the Kingdom of Saudi Arabia: 

• SATS is building new cargo facilities in Dammam in a greenfield project. It is the first foreign firm to enter the market. Dammam is a fairly busy airport in the Middle East and, according to industry periodicals, handled around 9.4m passengers and 95,000 tonnes of cargo in 2015. 
• Management indicated that while the new facilities will take some two years to build, SATS has already been able to secure temporary cargo facilities and sign on a large airline customer, ahead of plan. SATS is in discussions with other potential new customers as well.

Changi Airport Terminal 4 capacity addition: 

• Back in its home market, SATS has already incurred the start-up costs for Terminal 4, which commenced operations in the fourth quarter half of 2017. The terminal, which adds around 16m in passenger capacity (Changi Airport total capacity at c82m passengers now), will expectedly ramp up its capacity utilisation over the coming couple of years. This should allow SATS to benefit from scale economies and operating leverage.

Valuation and Risks 

Target price raised 7% to SGD6.10 

• We have raised our forward P/E-based target price by 7% to SGD6.10 from SGD5.70 from rolling forward to end-FY20 EPS (mid-FY20 previously) on a multiple of 21x (unchanged), equal to 1SD over its 5y mean.
• We believe the current 1SD premium over its mean will be sustained and justified over the coming 12-18 months due to:
  1. further upward revisions to consensus growth outlook; and
  2. our expectation of c250bps ROE improvement panning out by FY20.

Key risk factors 

• The key downside risk factors to our positive outlook thesis and forecasts are: 
• A material deterioration in airline industry fundamentals that will translate into pricing pressure and increasing competition among the aviation services providers.
• Execution and market risk in SATS’ various new ventures and investments. While the progress has been encouraging for a number of these ventures, payback periods are long for most and poor execution could translate to a drag on profits from current businesses.
• Risks specific to the proposed new venture with THY, which includes:
  1. greenfield execution risk in a new market; and
  2. the outside chance that the venture does not go through at all for whatever reason after the six-month MOU period is over.
• Market risks for TFK Japan where performance has been average at best in the past few quarters and the market remains in overcapacity and highly competitive.
• Currency risk as SATS derives c20% of revenues from overseas markets and this proportion is expected to grow in the coming years. That said, this is predominantly limited to translation risk for SGD group reporting as overseas operating entities’ revenues and costs are largely matched on the functional currencies of the respective entities.

Neel Sinha Maybank Kim Eng | http://www.maybank-ke.com.sg/ 2018-02-14

Maybank Kim Eng SGX Stock Analyst Report BUY Maintain BUY 6.10 Up 5.700