The Positives
The Negatives
The Negatives
The Positive
Outlook
Rising costs and interest expenses could impede earnings recovery. Working capital needs could rise with the inclusion of WFS. We downgrade to a REDUCE recommendation (from Neutral) and DCF-derived TP of S$2.23 (prev. S$2.51).
The Negatives
- Acquisition-related costs weighed on earnings. WFS was consolidated for the first time. It incurred a one-off integration cost (S$12.6mn), amortization of intangible assets (S$9.1mn), lease expenses (S$7.4mn) and cost for refinancing of WFS’ bonds (S$0.6mn). The final amount of intangible assets will be determined in 2H24e. The annual amortization could change.
- Net debt rose to S$2.2bn (Mar 23: S$0.77bn). Higher interest expense cancelled out all the operating gains. Free cash flow was negative S$10.7mn in 1Q24.
- Volume handled by WFS has declined in tandem with the decline in global air cargo demand. However, the industry decline is moderating (Jun 23: -3.4% YoY, YTD: -8.1%).
The Positive
+ SATS-only operations were profitable, though it no longer enjoy government relief.
Outlook
The outlook is mixed. Aviation-related profits could improve with 1) inflight meals restoring to pre-COVID levels; 2) reduction in double-catering; and 3) increase in number of flights. On the other hand, air cargo volume might remain sluggish from lower manufacturing output and trade activities. The higher interest expense is a drag on earnings.
The Negatives
- Cost escalation weighed on earnings. SATS reported higher operating loss of S$48mn (2H23: loss S$5.7mn) despite a 49.4% YoY gain in revenue, partly due to the consolidation of 65.4%-owned HK cargo handler Asia Airfreight Terminal which incurred losses. Total expenditure surged 48.1% as SATS restored to full capacity in anticipation of the ramp-up in flights by the air carriers. The number of commercial flights operating at Changi Airport was still 25% below pre-pandemic level in Mar 2023. Net loss excluding government relief was S$77.6mn. Staff costs rose 62% YoY and now account for 50% of total costs (FY22: 45%). Total employee count has returned to pre-pandemic level of 17,100. Higher inflationary pressure also lifted the cost of raw materials (+25.8%) and fuel and maintenance (+45.8%). SATS also incurred S$44.5mn for expenses relating to the acquisition of WFS.
- Mixed performance in the overseas markets. An uneven recovery in aviation in Asia and weaker cargo volume affected operations in Hong Kong, Malaysia and Saudi Arabia. Still, SATS is expanding central kitchen capacities in China and India to produce ready-to-eat meals for an uplift in international air travel and domestic consumption in these countries.
- Balance sheet turned into net debt of S$772.1mn, or net gearing of 0.33x. It has set aside S$1.8bn for the acquisition of WFS, which will be consolidated from FY24e.
The Positive
+ Nil
The news
SATS announced that it will undertake a renounceable, underwritten rights issue to raise gross proceeds of approximately $798.8mn to partially fund its acquisition of WFS. Entitled shareholders will be allotted rights to subscribe for 323 rights shares for every 1,000 existing shares held at the price of $2.20 per rights share, representing a discount of 16% to TERP.
The Positives
+ 9M23 revenue in-line, at 80.7% of FY23e. Seasonally strong 3Q23 revenue grew 54.5% driven by aviation recovery and Asia Airfreight Terminal (AAT) consolidation. Flight volume and air travel continue to recover as travel restrictions around the world eased. Its profitability continued to recover with core PATMI excl. reliefs at -$13.7mn vs. -$33mn in the same period last year driven by improved passenger-related operating statistics. We use core PATMI excl. reliefs as a measure of the Group’s profitability as this excludes one-off acquisition expenses and temporary government relief.
+ All necessary approvals from all jurisdictions received. With all the regulatory conditions for the transaction having been satisfied, SATS’ proposed acquisition of WFS is expected to close on 3 April 2023. The acquisition will strengthen SATS leading positions in strategic hubs connecting key trade lanes across North America and Europe, complementing its operations in Asia Pacific.
+ Funding clarity remove overhang. With the launch of the $800mn equity fund raising, we believe the overhang on the Company will be removed. At $2.20/rights share, this translates to an implied 15x FY24e (Figure 1), -1sd below its historical average P/E, which is attractive in our view. The theoretical ex-rights price (TERP) post-issuance is $2.62. Our target price of SATS represents a 11% upside to TERP.
The Negatives
- Higher share base post-completion from a lower-than-expected rights price. We had previously assumed a rights issue price of $2.29 based on a 15% discount. The steeper discount however, meant a slightly bigger dilution (-2%) to our FY24e earnings.
The news
SATS provided more details on its funding plan for the proposed acquisition of WFS.
The $700mn in term loan will comprise a 3-year Euro-denominated term loan with an all-in cost of 4-4.5% per annum based on prevailing Euribor.
The proposed rights issue is expected to be launched in 1Q23, subject to shareholders’ approval of the proposed acquisition at an EGM.
The Positives
+ Less concerned on discount of rights. With access to an acquisition bridge facility and the rights issue underwritten, we do not expect the discount for the rights to be steep. SATS had previously obtained an acquisition bridge facility of up to €1,200 million (approximately S$1,657mn) to fund and complete the proposed acquisition.
+ $700mn Euro term loan at 4-4.5% lower than our 5.5% forecast. We view the term loan positively, as it provides a natural currency hedge, and is also lower than we previously modelled. We tweaked our model slightly, taking the mid-point of the Euro term loan at 4.25% to lower our FY24e interest cost by approximately ~$7mn. The interest rates are also lower than the average 8-9% cost of debt currently borne by WFS.
Company Background
SATS is one of Asia’s leading providers of food solutions and gateway services, operating in countries across the Asia Pacific, UK, and the Middle East. Originally a subsidiary of Singapore Airlines, SATS divested from Singapore Airlines in September 2009, focusing on food solutions and gateway services. SATS has subsidiaries, associates and joint ventures across Asia and undertakes acquisitions and investments to grow its market share.
Investment Merits
Outlook
We are positive on the outlook for SATS. We see SATS as a prime beneficiary of the recovery in aviation travel. Post-consolidation of WFS, with gearing at ~58%, we believe SATS will embark on a deleveraging cycle of its balance sheet in order to be more aligned to its optimal capital structure of under 50%.
Initiating coverage with ACCUMULATE rating and target price of $3.02.
We initiate coverage on SATS with a BUY recommendation and a target price of $3.02. We peg SATS to a PE of 18.5x FY24e, which is -1sd below its historical average. We view SATS as best in class with a defensive business model and superior growth profile due to its overseas expansion plans and the expansion of new concepts. We believe SATS is at an inflection point and model the Group reaching breakeven point by 2H23e. We expect the Group to resume the payout of dividends by FY24e as the Group reverses back into profitability.
Background
SATS is one of Asia’s leading providers of food solutions and gateway services, operating in the Asia Pacific, UK, and the Middle East. Originally a subsidiary of Singapore Airlines, SATS divested from Singapore Airlines in September 2009, focusing on its food solutions and gateway services. SATS has subsidiaries, associates and joint ventures across Asia and undertakes acquisitions and investments to grow its market share.
SATS’ Food Solutions services (54.5% FY22 revenue) consists of inflight and institutional catering, food processing, distribution services and airline laundry services. Its Gateway services (45.3% FY22 revenue) comprises airport and cruise terminal services; and its airport services consists of airfreight handling services, passenger services, aviation security services, baggage handling and apron services to the groups handling customers. Its Cruise terminal services manages and operates Marina Bay Cruise Centre. The other operating segments are from the rental of premises and other segments (0.2% FY22 revenue).
Strategic plans
We believe the re-opening of borders globally will be a major re-rating catalyst for SATS. The relaxation of border restrictions for the last year have already seen its key metrics improve: number of passengers handled, flights handled, and gross meals produced by SATS has risen by 153%, 74% and 20% respectively YoY. Based on IATA’s travel recovery forecast, the aviation sector is expected to fully recover by 2024 and grow by 11% in 2025.
SATS is looking to deepen its expansion into the non-aviation sector to reduce its reliance on the aviation sector. It aims to do this through its experience providing safe and high-quality food – thanks to its reputable history of operating in the aviation section which requires the highest standard. SATS will leverage on this reputation when expanding into the non-aviation segment. It already has experience doing this. It currently serves about 20 Singapore Armed Forces camps; and served workers’ dormitories during the pandemic. It recently set up two retail restaurants - Twyst for its first foray into the B2C segment. Through its brand accelerator, FoodFlix, it has launched two signature hawker products under The Travelling Spoon label that will be available for a limited time only at 7-Eleven stores across Singapore.
SATS is also building on its capability in cargo management. Cargo revenue has already reached pre-crisis levels in FY22 and our base case assumes a 13-15% increase in the next two years. Its acquisition of WFS will expand the Group’s capability in cargo management, and give it a foothold in key trade routes in the United States and North America-Europe routes. It will also reinforce the Group’s earnings resilience and diversification that management set out as part of its five-year plan.
We believe SATS will continue to grow new revenue streams through various M&As and strengthen capabilities to ensure the growth and sustainability of the businesses across the value chain. SATS invested $150min Jurong Food Hub, acquired an 85% stake in Food City Company Limited (Thailand), a frozen food producer for a cash consideration of $20.4m, as well as acquiring an additional 16.4% to own a total of 65.4% stake in Asia Airfreight Terminal Co (Hong Kong), a cargo terminal operator for $58.5m. We expect SATS to further diversify its revenue streams going forward.
Investment Merits
Initiating coverage with ACCUMULATE rating and target price of $3.02.
We initiate coverage on SATS with a BUY recommendation and a target price of $3.02. We peg SATS to a PE of 18.5x FY24e, which is -1sd below its historical average. We view SATS as best in class with a defensive business model and superior growth profile due to its overseas expansion plans and the expansion of new concepts. We believe SATS is at an inflection point and model the Group reaching breakeven by 2H23e. We expect the Group to resume the payout of dividends by FY24e as the Group reverses back into profitability.
Acquisition of Worldwide Flight Services to accelerate SATS transformation
SATS has agreed to acquire 100% of WFS, the largest air cargo handler for €1,187mn (~S$1,639mn) or an enterprise value of S$3.11bn, indicating EV/EBITDA of 9.7x. We view the 9.7x EV/EBITDA valuation of WFS as largely in line with past peer transactions of between 10.1x-10.7x.
The decision to acquire WFS is driven by the opportunity to expand SATS’ market reach beyond APAC into US and Europe with leading positions in strategic hubs connecting key trade lanes across North America and Europe. SATS and WFS operate in different geographies without operational overlap in the cargo handling space (Figure 3).
Post-acquisition, SATS would have comprehensive global coverage across Americas-Europe-APAC covering trade routes responsible for more than 50% of global air cargo volumes. It will also have the ability to support needs of global customers with end-to-end solutions.
SATS has identified meaningful run-rate EBITDA synergies in excess of $100mn over 3-5 years for its acquisition of WFS. Importantly though, the management guided that the bulk of these synergies will come from revenue synergies from network expansion and not cost synergies. We believe this represents a greater challenge to management. Despite this, the management remains confident and guided that up to 40% of these synergies can be realised in the next two years. We have opted to be conservative in our modeling of WFS, and have omitted potential synergies that can be realised from the acquisition. The realisation of these synergies presents upside bias to our FY24e forecasts.
The acquisition is expected to be earnings accretive to SATS, with pro forma EPS of 5.4 Singapore cents (excluding the effect of intangibles amortisation) and 3.2 Singapore cents (including intangibles amortisation).
SATS funding clarity on WFS to reduce overhang
SATS has provided clarity on its funding structure for the WFS acquisition by committing to a cap of $800mn on the rights issue (Figure 5). The rest of the funds will be funded by term loans of $700mn and internal cash. We believe the latest clarity on its funding structure will alleviate some of the overhang on the stock from the uncertain funding structure. The move to shift a greater portion of its funding requirements to debt we believe is motivated by the lower cost of funding (vs placement) and dilution given the sharp correction in its shares by over 33% since news of the acquisition broke. We model a 5.5% cost of financing for its term loans, payable in three to five years.
We have provided an illustration of the possible rights issue funding structure in Figure 6 to illustrate the effects of the rights issue that SATS will announce likely in November or December.
Shareholders will be able to subscribe to the rights at an issue price of $2.29 or a 15% discount to the current share price. The rights issue could be made on a renounceable basis to entitled shareholders on the basis of three rights share for every 10 held by entitled shareholders.
Temasek, its largest shareholder (39.76% stake) has provided an irrevocable undertaking to vote in favour of the transaction and intends, subject to the terms of the rights issue to be finalised, to subscribe for its pro rata entitlement to the rights issue.
Even though the acquisition of WFS will drive up its net debt from ~3% to ~39% (Figure 7), we believe the Group will embark on a deleveraging cycle post-acquisition to reduce its overall funding costs. We believe this enables them to have capacity to continue to invest in growth to cope with increasing business activities, as well as M&A opportunities to expand its regional operations. We expect net debt to be lowered to ~29% by FY24e due to the strong cash flow generation capability of WFS.
In terms of timeline, SATS intend to make the funding announcement by November or December, with the EGM to be held in January 2023. The target completion date for the acquisition is in March 2023.
The Positives
+ Driving costs lower. Excluding government relief, operating costs were down S$212mn or 25% YoY. The bulk or S$167mn was from lower staff costs. Headcount dropped 24% YoY to 13,000. Raw-material costs only dropped 13% YoY or S$19mn.
+ Certified to transport vaccines. SATS says it is certified to handle the transportation of vaccines even in extreme environments. It has handled vaccine shipments that require minus 80 degrees. This involves liquid nitrogen cooling with the vaccines inside.
The Negative
- Operating conditions still sluggish. Revenue weakness was due to poor aviation traffic. 1H21 flights handled declined more than 84% YoY. In tandem, meal volumes collapsed 93-97% YoY. Cargo fared better, with tonnage down 45% in Singapore but steadily improving. There are constraints in the supply of planes to ship cargoes. The surge in e-commerce is driving demand for cargo handling.
Outlook
We do not see any meaningful recovery for the aviation sector in 2021. The near-term positive surprise has been the level of government support, with subsidies on track to surpass one year PATME for SATS. The company is making long-term investments to pivot away from aviation to the handling of e-commerce, perishable and pharmaceutical products.
Upgrade to NEUTRAL from SELL with a target price of S$4.40, up from S$1.95
We last pegged our target price at its GFC average of 1.35x P/BV. We now believe this is too bearish as operations have likely bottomed and vaccine-discovery newsflow turns positive. With losses still expected in FY21/22e, we continue to value SATS at historical P/BV. As its 3-year average of 3.5x is too high given its still-fragile recovery and uncertain outlook, we use 3.3x. This is the bottom end of its pre-Covid valuation band or 1SD below average (Figure 1).
The Positives
+ Restructuring staff cost. Staff cost excluding the S$61.7mn government relief was cut by around 32% YoY in 1Q21. The number of employees has been lowered by 19% YoY to 13,500.
+ Cargo is relatively stronger. Cargo segment has performed relatively better than other segments. Cargo handled declined 51% to 221k in 1Q21, in comparison passengers handled tumbled 99% to 0.2mn.
The Negatives
- Associates a major source of weakness. With government relief, SATS suffered an operating loss of S$36mn. It was comparable to the S$31mn losses by associates and joint venture. China was the largest drag to associates. The closure of Beijing Daxing Airport was a reason for the losses in China.
Outlook
FCF in 1Q21 was a negative $71mn. With a cash balance of S$723mn (net debt: S$152mn), SATS can easily ride out the current downturn or another 10 quarters of the similar level of FCF cash burn-rate. SATS has likely bottomed out operationally but we worry such listless conditions may persist for another three to four quarters.
Maintain SELL with a target price of S$1.95
Without any clarity of a sustainable and material improvement in air travel and net losses to persist for the company, we maintain our SELL recommendation with an unchanged target price of S$1.95. Our forecast is unchanged.
The Positives
+ Responding with aggressive cost cuts. Excluding the government grant of S$21.9mn (two months) in 4Q20, SATS has managed to lower staff cost by 16% YoY, more than the 8% decline in revenues. Some of the lower cost driven by pay cut from management in late February, less overtime, reduced contract services, foreign worker levy rebates and property tax / rental rebates.
+ Other sources of revenue. Some of the new areas of revenue includes wholesale supplier to cloud kitchens catering to home deliveries. Another source of revenue was cruise centre support to house foreign workers in cruise ships.
The Negatives
- No final dividend. The was no final dividend compared with 13 cents a year ago. The company needs to be prudent and retain cash due to the uncertainties.
Outlook
Liquidity will more critical than any elusive profitability this year. We expect a severe contraction in aviation revenues, which accounts for 76% of 4Q20 revenues. The company geared up with S$305mn loan proceeds in 4Q20 to amass S$549mn of cash on its balance sheet. If we annualised 4Q20 fixed cash operating cost (staff, utilities, other costs), the run-rate will be around S$1bn. More aggressive cost cuts are needed. SATS is temporarily closing Inflight Catering Centre 1 (ITC 1) and consolidate operations at ITC 2. 1Q20 guidance is for a net loss of S$50mn.
Downgrade to SELL from NEUTRAL; Lower target price to S$1.95
The path to recovery is unclear. Absence of dividends and net losses to persist, a more conservative benchmark to valuations will be the price to book ratio. We have taken the average of 1.35x during the global financial crisis in 2009 as a benchmark for our valuation.
