SATS Ltd: Good turnaround at various levels July 20, 2018

PSR Recommendation: ACCUMULATEStatus: MaintainedTarget Price: SGD5.58
  • Revenue and PATMI exceeded our expectation by 6.8% and 5.7% respectively
  • Revenue and PATMI met 25.7% and 25.3% respectively of our FY19 estimate
  • Inflight kitchen JV with Turkish Airlines has been terminated
  • Kunshan central kitchen turned profitable ahead of schedule
  • MBCCS has turned profitable as well
  • Maintain Accumulate; unchanged target price of $5.58

The Positives

+ Higher Food Solutions (FS) revenue driven by higher meal volumes across the Group. TFK Corp. (inflight kitchen subsidiary based in Tokyo) experienced a 3.1% YoY increase in revenue. However, the higher meal volumes was partially offset by lower pricing, as airline margins are still constrained by strong competition in Asia. Cost of raw ingredients is also expected to continue to increase. Raw materials cost was 10% higher YoY, despite FS revenue increasing by 2.7% YoY.

+ Higher Gateway Services (GS) revenue driven by both Aviation and Non-Aviation; and was the key driver to Group EBIT margin improvement. There was an increase in air cargo tonnage and flights handled. In addition, the cruise terminal at Marina Bay Cruise Centre Singapore (MBCCS) benefitted from higher ship calls and increased passengers handled. Air cargo is a high operating leverage business which benefited from the higher volumes (better flow through to bottom line), while the cruise centre turned around to profit.

+ 9% YoY higher Non-Aviation revenue to S$60.2 mn (13.7% of Group revenue). This was due to revenue growth from the Kunshan central kitchen and MBCCS; both of which have turned profitable (refer to further details overleaf).

The Negatives

– Lower associates/JV contribution. This was due to a soft quarter in Indonesia for PT CAS and PT JAS, but partially mitigated by existing and new associates/JVs.

Outlook

The outlook is positive. Passenger volumes in Asia is expected to grow, given the backlog of aircraft on order and airport expansions across the region. MBCCS has turned around and ship calls are expected to be sustained. The Kunshan and Langfang central kitchens are poised to benefit from urbanisation and demand for safe, high-quality food. SATS has been investing in technology to boost productivity in anticipation of higher volumes, with staff cost (variable cost) progressively replaced by depreciation (fixed cost). Impact from a trade war that materialises is limited for now, but would be the key risk to earnings.

Maintain Accumulate; unchanged target price of $5.58

We like the stock for its regional expansion story and growth initiatives. Our target price gives an implied FY19e forward P/E multiple of 24.7 times.

Appendix

Here are the key takeaways from Management sharing of updates.

Mutual agreement to terminate Memorandum of Agreement for inflight catering JV with Turkish Airlines

  • Istanbul New Airport will be opening in October and poses operational risks for participants in moving from Istanbul Atatürk Airport
  • Turkish Airlines was not able to terminate its existing agreement with the incumbent cater; so SATS has decided that it is not beneficial to proceed with the catering agreement
  • Sunk costs such as travel expenses have been immaterial and were expensed in prior quarters, with no additional expenses to be expected

Marina Bay Cruise Centre Singapore (operator JV with Creuers del Port de Barcelona)

  • Seasonal business, but Management has visibility over the next twelve months and is confident that volume will sustain for the rest of the year
  • Cruise centre was losing money, but has now turned around with the increase in ship calls and margins have exceeded the Aviation Gateway segment
  • About half of the improvement in Gateway Services EBIT was due to the improvement at the cruise terminal
  • Singapore is an attractive cruise destination for its good weather, local itineraries, airport for people to fly in and marine maintenance facilities

Kunshan central kitchen on outskirt of Shanghai, China (JV with Yihai Kerry)

  • Was expected to be profitable after three years, but has already turned profitable after two years of operations

Langfang central kitchen on outskirt of Beijing, China (recently announced JV with WI Kitchen, a subsidiary of Wilmar)

  • Will carry out the exact same business as the Kunshan central kitchen – large scale food catering and developing menus for food service chains
  • Catering of meals in small batches to sample at restaurants and tweak the taste before progressively ramping-up production
  • Food/sauces will be delivered in bulk to customers’ distribution centres and customers will use their own logistics supply chain to distribute to restaurants

Impact from possible trade war

  • Air cargo business could be impacted; but so far no impact has been observed
  • Nonetheless, SATS has low exposure to direct cargo between China and USA
  • AAT (ground handler JV based in Hong Kong) has exposure to China

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Richard Leow
Investment Analyst
Phillip Securities Research Pte Ltd

Richard covers the Transport Sector and Industrial REITs. He graduated with a Master of Science in Applied Finance from the Singapore Management University. He holds the CFTe and FRM certifications and is a CFA charterholder.

He was ranked #2 Top Stock Picker (Asia) for Real Estate Investment Trusts in the 2018 Thomson Reuters Analyst Awards, and ranked #2 Top Stock Picker (Singapore) for Resources & Infrastructure in the 2016 Thomson Reuters Analyst Awards.

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