• 3QFY20 revenue was better than expected. Earnings missed due to weaker margins. EBIT margins impacted by cargo weakness, increased IT expenses and higher contribution of newly consolidated Country Foods.
• Associate earnings fell due to start-up losses at new Daxing operations and exclusion of prior year gain on of sale of S$5.8mn from DFASS to KrisShop.
• The outlook is uncertain with the outbreak of COVID-19 virus. SATS revenue will suffer from the dip in aviation traffic and closure of restaurants in China. Our FY20e PATMI is cut by 23%. As a gauge of the impact, the Singapore Tourism Board mentioned a possible 25-30% fall in visitor arrivals in 2020 due to the outbreak.
• Downgrade to NEUTRAL from ACCUMULATE with a lower target price of $4.45 (prev. S$5.36). Excluding the acquisition, core revenues were flat. We think SATS will require some time to recover from the depressed volumes triggered by COVID-19 virus and to grow the organic earnings of their recent acquisitions

The Positives

+ Revenue better than expected due to acquisition. Revenue jump of 17% YoY in 3Q20 was entirely due to consolidation of Country Food and acquisition of Ground Team Red (GTR) and Nanjing Weizhou. Core revenue would have been flat excluding the acquisitions.

+ Japan to grow even faster. Revenue from Japan rose 10.6% YoY in 3Q20 to S$70.5mn. It is the 3rd largest geography for SATS after Singapore (contributes S$432.6mn or 60% of Group revenue) and Greater China (S$97.2mn or 13.6% of group revenue). SATS has invested in sufficient capacity to benefit from increased slots at the Haneda airport.          

The Negatives

– Core EBIT margins depressed. When we exclude the acquisition, EBIT would have dropped around 9.6% to S$59mn. The new entities contributed around S$3.9mn incremental EBIT, from our estimates. This is reflected by Singapore PATMI falling 14.2% YoY in 3Q20 despite a 4% improvement in revenues.

Outlook

We see multiple near-term challenges ahead for SATS. Even before the outbreak, core earnings in Singapore was weak due to soft cargo volumes, possible lower pricing and higher expenses. The situation is exacerbated the virus outbreak, affecting other parts of the business, namely passenger traffic in all airports and food business in China.

Downgrade to NEUTRAL from ACCUMULATE; Lower target price of $4.45

We slash our FY20 earnings by 23%. Our lower target price is due to the cut in earnings, reduced terminal growth to 1% and cost of equity raised to 8% in view of the increased uncertainty and risk surrounding the current environment. This pegs SATS to 19x PE FY21e.