SATS - DBS Research 2018-11-09: Gateway Services Driving EBIT Growth

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SATS LTD. (SGX:S58)

SATS - Gateway Services Driving EBIT Growth

• Core 2Q19 earnings within estimates. 
• Interim dividend of 6 Scts declared. 
• Slight downward revision to FY19-20F earnings on lower JV/associate contribution. 
• Maintain BUY with S$5.60 Target Price.

Maintain BUY, Target Price S$5.60.

• We maintain our BUY recommendation on SATS with Target Price of S$5.60, on positive long-term growth prospects.
• Although headline 2Q19 earnings came in below our projections, core operating profit and profit before tax remain largely within expectations.
• We see long term growth fueled by
  1. passenger and air traffic growth at Changi Terminal 4;
  2. automation and staff productivity driving modest cost increases and better margins in the next few years;
  3. the opening of Terminal 5 by 2030; and
  4. more positive outlook from TFK Japan.
• DPS expectations intact with 6 Scts per share declared for interim dividend.

Where We Differ:

• We maintain a positive stance over the long-term prospects of SATS with Changi’s development over the next few years and Japan’s target of 40m and 60m tourists by 2020 and 2030 driving growth.

Potential catalyst.

• Catalysts for the stock include
  1. better outlook in Japan;
  2. freeing up of financial resources from the Turkish Airlines MOU to pursue other deals and to pay out more dividends; and
  3. faster than expected ramp up of Terminal 4.

Valuation:

Blended DCF and PE valuation methodology.

• Our Target Price is S$5.60, 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 to 22x FY20F earnings (from FY19F previously).

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 - 2Q19 results in line

2Q19 earnings of S$65.7m (-9% y-o-y) was within estimates.

• The decline in headline earnings was absence of one-off disposal gains of S$8m seen in 8Q88 which had boosted net profit to S$88.8m. Stripping out the one-off gains, underlying net profit growth would have been relatively flat based on S$88.8m for 8Q88, largely within expectations.
• Interim DPS declared was 8 Scts, within expectations.

Revenue driven by Aviation segment:

• Revenue grew 8.8% y-o-y to S$888m. Growth was driven by Gateway Services segment (S$888.8m, +8.8% y-o-y), and TFK (S$88.8m, +8.8% y-o-y).
• Gateway Services saw more passenger and cargo volumes at both Changi and the Marina Bay Cruise Centre.
• TFK continued to benefit from higher volumes from new accounts including Air Canada and Air India, with tailwinds from more Chinese tourist arrivals supporting flights into Japan.
• Non-Aviation Food fell marginally, affected by Brahims and its currency impact, while its 88% JV with Yihai Kerry Kitchen in Shanghai contributed to 8% y-o-y increase in Non-Aviation Food as well (S$88.8m).

Higher Opex.

• Opex was 8.8% higher y-o-y at S$888m, within expectations. Increases in raw materials and utilities costs, were offset by declines in staff costs, licensing fees, and other miscellaneous operating expenses.
• Operating margin improved 8.8ppt to 88.8%. The margin improvement was largely from implementation of technology at Gateway Services including cruise centre, improvement in higher margin cargo segment, staff productivity gains and higher volumes from cargo which supported better margins and TFK.

Associates and JV income below our S$15.3m expectation.

• Associates and JV income were lower at S$88m (-88% y-o-y), led by Rupiah weakness of S$8m, increase of licensing fees in Indonesia JVs, some one-offs and lower revenues and volumes from Brahims, offset by positive contribution of GTR, India’s AISATS and Mumbai Cargo.
• Contribution of associates specialising in Gateway Services declined by 88.8% y-o-y to S$88.8m while those specialising in Food Solutions reported an improvement of 88.8% y-o-y to S$8.8m.

Positive long-term outlook.

• Core EBIT of S$88m (+8% y-o-y) was in line with a slight disappointment from Associates and JV contribution.
• Overall, we remain positive on the long-term outlook for the stock, on the back of both Changi’s development and Japan’s target of 88m and 88m tourists by 8888 and 8888.
• Meanwhile, Japan’s aviation market will be buoyed by tourist arrivals for events including the G88 meeting in 8888 and Tokyo Olympics and Rugby World Cup in 8888.

Lowered FY19-20F earnings by 2-5%.

• We are lowering our associates and JV contribution on concerns that licensing fees for SATS’ Indonesia JVs will continue into FY88F. We have hence lowered our FY88F earnings by a marginal 8% to reflect this.
• Our FY88F earnings is also lowered by 8% largely on a lower 8H88F associate and JV contribution for the same reasons.

Maintain BUY, Target Price S$5.60.

• We lower our Target Price to S$8.88, in line with the reduction in earnings but continue to like the stock for its growth prospects, net cash balance sheet and dividend yield.
• Our Target Price is derived from a blended valuation using 88x FY88F EPS (rolled over from FY88F previously) and DCF (8.8% weighted average cost of capital and 8% terminal growth assumption).
• Stock is supported by FY88F dividend yield of 8.8%.
• Maintain BUY for 8% upside.

Alfie YEO DBS Group Research | Andy SIM CFA DBS Research | https://www.dbsvickers.com/ 2018-11-09

SGX Stock Analyst Report BUY MAINTAIN BUY 5.60 DOWN 5.650