SATS - CGS-CIMB Research 2019-05-30: The S$1bn Dollar Question

SATS LTD. (SGX:S58)

SATS - The S$1bn Dollar Question

We like SATS LTD. (SGX:S58)’s S$1bn capex/investment plan for the next three years which should add 6% to our FY22F EPS and imply a Target Price of S$6.39 at 21x P/E.
Digitalisation is the buzz word to scale its business and optimise costs. SATS also expects to sustain dividends with a 30% D/E ratio in 3-5 years.
Maintain ADD and Target Price of S$5.46 on 21x CY20F P/E.

We are positive on SATS LTD. (SGX:S58) riding the secular trend of ecommerce (cargo) and air travel (ground handling & inflight catering). Digitalisation of cargo platforms and food supply chain network is key to optimising costs and scaling up the business.
SATS’s mission is to be the Asia-Pacific market leader in aviation catering and ground handling as well as central kitchen for the food industry in China and India. Developing digital travel retail capabilities for passengers is also one of SATS’s near-term priorities.

We think SATS is aggressive to set a target of S$1bn greenfield/brownfield capex and/or investments over the next 3 years (including productivity enhancement on more modern equipment). This is on top of 3-5% maintenance capex (S$80m-90m p.a.).
The M&As will be bolt-on sites, building on existing businesses and not transformational transactions. They will also be dominated by medium-sized to larger hubs in China and India.
SATS’s WACC is 7%, with blended target return of 8% based on past records. Assuming 70% of the S$1bn are M&As with 2-year gestations, we estimate c.S$19m p.a. of profit from FY22F, or 14% y-o-y growth. This adds 6% to our FY22F EPS and implies Target Price of S$6.39 on 21x P/E. SATS also plans to have a more active capital structure of 30% debt/equity ratio over the next 3-5 years (FY19: D/E ratio at 5%). We estimate net gearing rising to 10% accordingly from net cash currently.

We appreciate the detailed segmental breakdown provided on its associates/JVs. Currently, Greater China accounts for 28% of SATS associates/JVs, mainly driven by AAT HK (cargo) and Evergreen group in Taiwan. China contribution (Kunshun Food, Beijing Airport Inflight Kitchen and Beijing Aviation Ground Services) is not material currently (we estimate profit to be less than 2% of group).
India ranks no. 3 in associates’ earnings contribution with c.75% in cargo. We think the impact from the Jet Airways downfall could be mitigated by passengers switching to other airlines such as Vistara, Indigo and Air India, which are all SATS customers.

Execution is key, be it its digitalisation platform or expanding supply chain network in food solutions. We think investors will reward SATS if it is able to grow profits above high-single-digit-growth. Economy slowdown is a risk.
Click here for the slides.

Our base case assumes 70% of the S$1bn to be M&A, or c.S$230m in size p.a with two years of gestation. We think SATS is able to handle such scale. Recall that the acquisition GTR was S$160m in 2018 and TFK at S$122m in 2010. This is provided that the target acquisition is profitable from the onset, to cushion potential downside of gestation.

This is new to us. The latest acquisition in Nanjing Weizhou frozen airlines food business is an example of tier 3 kitchen which build upon SATS’s existing capabilities and capture the entire food solutions network ecosystems. Although margins may be lower as it moves down the value chain (we estimate 6-8% net margin), we believe volume and scalability are key.
- Tier 1: localised (in flight kitchen)
- Tier 2: central kitchen
- Tier 3: bulk production (food factories).

SATS strategy to grow its central kitchen businesses in China is strategic but will take time to contribute meaningfully, in our view. Its Kunshun kitchen serves 50,000 meals/day and delivered S$8m in FY19. The upcoming Tianjin kitchen target to deliver 100,000 meals/ day (cost: Rmb120m) will come on stream by 2020.
Some of SATS non-aviation customers in China include: Yum group, Walt Disney, Happy Valley theme park, Luckin coffee and Hai Dai Lao.

Although not quantifiable to the bottom line for now, we appreciate SATS focus to transform current silos within supply chains to a digitally connected one for its gateway services. We think the bigger plan is to have an end-to-end digital solutions to capture the ecosystems from shipper, freight forwarder, custom, airline through to warehouse, last mile and customer.
Data analytics and predictive artificial intelligence will be used to make SATS a partner of choice among airlines for its ground and passenger handling services.

We believe India is the growth market. The acquisition of 49% stake in Mumbai Cargo Service Centre in 2017 paid off and as it opened up new markets such as Delhi and Chennai which SATS previously had no presence. It generated S$88m of revenue (on 100%) in FY19 and we estimate EBIT of c.S$4m based on similar ground handling margin attained by Air India SATS of 9% achieved in FY18 (disclosed in Annual Report). This is a successful case in point of high return of investment with minimal gestation pains.
SATS management elaborated that the current key challenge in India is awaiting/ bidding for tenders for new contracts, hence the need to grow beyond organically.
See Figure5 in attached PDF report for the overview on SATS' associates and JVs by region.
See SATS's announcement dated 30-May-2019 for SATS' Presentation Slides for Capital Markets Day.

LIM Siew Khee CGS-CIMB Research | https://research.itradecimb.com/ 2019-05-30

SGX Stock Analyst Report HOLD MAINTAIN HOLD 5.460 SAME 5.460