SATS - UOB Kay Hian 2019-10-15: Looking Beyond Singapore For Long-term Growth; Upgrade To BUY

SATS LTD. (SGX:S58)

SATS - Looking Beyond Singapore For Long-term Growth; Upgrade To BUY

While short-term headwinds continue to drag cargo earnings, SATS is investing for long-term growth in overseas markets with S$1b capex commitment over the next three years.
We expect 2QFY20 associate earnings to improve q-o-q. A reduction in Sino-US trade tension will also benefit SATS. Management affirms a sustainable dividend payout policy, implying dividend payout is likely to be maintained in FY20. See SATS dividend history.

SATS LTD. (SGX:S58) has outlined the importance of investing outside of Singapore, despite having a greater than 80% market share on inflight catering and ground handling locally. To that extent, SATS will focus on extending its reach in inflight catering within the Asia Pacific region and to complement that by establishing:
1. central kitchens to serve fast casual restaurants in China and India; and
2. food factories to vertically support the central kitchens and other restaurants.
SATS expects the fast service casual restaurant market in China and India to expand by 4% and 6% CAGR respectively in 2017-23. In China, SATS has a central kitchen in Kunshan and it supports restaurants such as Haidilao, Yum Brangs, Walt Disney Shanghai, StarHub (SGX:CC3) and Astons. When SATS’ central kitchen in Tianjin becomes operational in two years’ time, it could serve the same restaurant chains, leveraging its reputation for safe and reliable food.

SATS affirms that the North Asian regions are harder hit than the other regions in Southeast Asia due to supply chain disruptions arising from trade tensions between the US and China. Meanwhile, an economic slowdown has impacted semiconductor and other electronics shipments.
In Hong Kong, SATS’ 45%-owned Asia Airfreight Terminal (AAT) has been impacted by civil protests and we reckon the unit would be operating in the red for the quarter. SATS however indicated that much of the pressure comes from lower volume and that yields on cargo handled have not been impacted. SATS also noted that it is planning to redeploy manpower sources to reduce overheads.

SATS cited that its recent acquisition of SATS BRF (acquired the balance 49% stake in Sep 19 to 100% ownership) was strategic as it would be able to reap cost and procurement synergies, which could be extended to inflight catering operations. SATS also emphasised that labour productivity initiatives are ongoing.
In 1QFY20, SATS’ staff cost rose 10% y-o-y, partly due to the consolidation of Malaysian associate, Ground Team Red (GTR). For the remaining of FY20 we are assuming a 9.5% y-o-y increase. If the pace of staff cost increase moderates, this could reduce the impact of slower gateway services revenue.

In 1QFY20, the grounding of Jet Airways led to lower revenue out of Singapore and associate earnings were also impacted by S$3.3m. We reckon that the revenue shortfall could be mostly alleviated as the slots have been filled by Singapore Airlines (SGX:C6L)-owned Indian airline, Vistara. SATS’ Indian inflight catering associate earnings should similarly see q-o-q improvement.

In 1QFY20, gateway services revenue fell 4.2% y-o-y due to weak air cargo revenue as well as the grounding of Jet Airways. We estimate a slower rate of decline in 2QFY20 as Vistara has picked up the slots that were previously operated by Jet Airways. Thus, net margins are unlikely to deteriorate further from the 9.1% in 1QFY20.
SATS also indicated that its Mumbai air cargo associate had made positive contributions in 1QFY19 and thus we expect y-o-y improvement in the coming quarters.

We believe that most of the known negatives are already reflected in SATS share price. Going into 3QFY20, some of these negatives could ease. The decline in air cargo volume could abate due to a low base in 4Q19 and a potential resolution in the Sino-US trade war.
We are also encouraged by SATS’ guidance that yields have not deteriorated. Given the relatively high operating leverage for the gateway segment, an improvement in air cargo volume and revenue would have an amplified impact on earnings. In addition, SATS’ ROE could improve upon the acquisition of food factories as the company aims to fund acquisitions partly by debt.

We raise our FY20 net profit forecast by 3% after factoring in better associate earnings and lower staff costs.

We have tweaked our long-term ROIC assumption from 14.6% to 14.8%, assuming overall returns would improve with strategic investments in China and India.
We have also raised our long-term growth assumption to 2.5% from 2.2%, factoring in SATS’ ability to leverage up.

K Ajith UOB Kay Hian Research | https://research.uobkayhian.com/ 2019-10-15

SGX Stock Analyst Report BUY MAINTAIN HOLD 5.30 UP 4.800