SATS - UOB Kay Hian 2021-03-19: Ready For Border Re-openings; Exploring M&A Opportunities

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SATS LTD. (SGX:S58)

SATS - Ready For Border Re-openings; Exploring M&A Opportunities

• At S$4.56, SATS's share price is trading at just 5% below pre-COVID-19 level, implying that the street is swiftly pricing in a recovery.
• Operationally, we sense there would be significant operating leverage as flights resume, but a key uncertainty is the impact on margins from changes in inflight catering. SATS also appears to be on the lookout for bolt-on acquisitions, possibly in China or India to add scale to its operations.
• At current price, SATS is trading at 22.7x pre-pandemic earnings. Maintain HOLD. Target Price: S$4.27.

Challenging environment, but SATS is prepared for the uptick in traffic.

• SATS (SGX:S58) indicated that travel bubbles are likely to form over the next six months, which should lead to a higher number of flights, and implicitly a higher number of meals served. This should boost gateway-services revenue and lower losses at the food solutions business.
• SATS also highlighted that as borders reopen, inflight catering would involve bento box-like meals, to minimise contact between crew and passengers. It remains to be seen as to whether this will impact margins on meals served.

Government grants to taper off in 4QFY21, but the latest government support measures would extend grants till 1HFY22.

• Mindful of the reduction in grants, SATS is looking at new revenue streams and other cost savings measures to offset the earnings impact for 4QFY21 (Jan 2021 to Mar 2021). A reduction or cessation in impairments could also offset the impact of lower government grants.
• In 3QFY21, SATS recognised S$22.5m in impairment charges along with a S$5m provision for doubtful debt. For 4QFY21, we have assumed a net profit of S$11.9m vs 3QFY21’s S$2.8m loss. Meanwhile, the street has an implied net profit forecast of S$47m for 4QFY21.
• For 1HFY22, we now estimate that SATS will receive S$84m in government grants.

High operating leverage from cargo terminal operation, but reopening of borders should also lead to positive JAWS in margin.

• SATS stated that cargo volumes at Changi have now risen close to pre-pandemic levels, and it has also gained market share. Post pandemic, SATS expects greater reliance on e-commerce shipments with higher focus on air cargo for critical supply chain needs. Investments in digitalisation should lead to high operating leverage, and current margins at cargo handling operations are guided to be in the teens.
• Some operators were said to be achieving almost 30% margins. SATS's utilisation of its perishables handling centre is high but asset turnover is also relatively high due to a greater degree of automation and more efficient distribution.

Does not expect a substantial increase in overheads as catering operations ramp up.

• As at end-3QFY21, SATS had reduced headcount by 33% y-o-y and expects further reduction in 4QFY21. While acknowledging the need for increased headcount as borders reopen, SATS does not expect a proportionate increase in headcount.
• When queried about inflationary pressure on raw material costs, SATS indicated that its global procurement network for its commercial and national food supply has led to cost efficiencies and has offset some of the increase in prices.

Continues to develop non-travel revenue streams in Singapore, China and the UK.

• In China, SATS’s central kitchen in Kunshan provides safe high-quality food to fast-casual restaurants including Yum China, Starbucks, Costa Coffee, Alibaba’s Hema supermarket, Aldi supermarket as well as local schools in Suzhou. SATS is also building a new kitchen in Tianjin. The goal is to achieve scale by replicating the distribution of food to other provinces as these chains expand throughout China.
• In India, SATS is seeking bolt-on acquisitions of food factories to complement its food distribution to fast casual restaurants.

S$2b in Medium Term Note facility likely to be a prelude to M&A.

• SATS reiterated that any acquisition is likely to be bolt-on, without the requirement for substantial working capital. We reckon that acquisitions would likely involve food factories in China or India.

Key takeaway is the likelihood of high operating leverage from border openings due to cost containment.

• SATS’s guidance that labour cost might not rise in lockstep with increased flights would imply a faster margin recovery post COVID-19. However, to some extent, this would also be dependent on meal pricing. Pre-COVID-19, SATS had already faced pricing pressure from airlines, and if unit meals are lowered, margin growth could be curtailed.
• As for the M&A angle, we are neutral at this juncture, given our view of SATS’s uneven track record.

A question of fair value multiples.

• Pre-COVID-19 in 2019, SATS traded at an average of 25x 2019’s earnings, with multiples being justified due to its monopolistic status at Changi Airport. However, we believe such multiples might no longer be justified post COVID-19, due to the cyclical nature and volatility of the aviation industry.
• We lower our SATS's FY22 earnings estimate by 27%, primarily due to lowered Jobs Support Scheme payout estimates. However, we raise our FY23 net profit estimate by 19%, factoring in slower wage growth and stronger associate earnings.

Maintain HOLD on SATS but raise target price from S$4.07 to S$4.27.

• We move our valuation methodology from DCF to EV/Invested Capital. At our fair value, SATS would be trading at 20.2x FY23’s earnings and 21x pre-COVID-19, 2019 calendar year average P/E.
• See SATS Share Price; SATS Target Price; SATS Analyst Reports; SATS Dividend History; SATS Announcements; SATS Latest News.

K Ajith UOB Kay Hian Research | https://research.uobkayhian.com/ 2021-03-19

SGX Stock Analyst Report HOLD MAINTAIN HOLD 4.270 UP 4.070