• FY17 revenue in line with our forecast and consensus expectation
• FY17 underlying PATMI missed our forecast by 3.6%, and missed consensus expectation by 4.0%, as 4Q17 underlying PATMI was dragged down by higher costs
• Final dividend rose to 11 cents (our forecast: 10 cents) from 10 cents in FY16
• Total ordinary dividends of 17 cents for FY17, higher than 15 cents from last year

FY17 margin and profit was dragged down in 4Q17

FY17 EBIT margin of 13.3% was better than the 12.6% achieved in FY16. However, there was YoY weakness in 4Q17 EBIT margin of 10.8% from 11.9%. This was in contrast to the first three quarters of FY17, which experienced YoY higher margin that was driven by the deconsolidation of the lower-margin food distribution business to the SATS BRF joint-venture. 4Q17 operating cost was higher due to a few factors – higher wage pressure (due to service increment and lower government subsidies), higher company premises and utility expenses (due to non-renewal of rebates by Changi Airport Group) and higher other costs. Consequently, 4Q17 underlying PATMI was only 1.8% YoY higher. (9M17 underlying PATMI was 9.1% YoY higher.)

Associates received a $15 million boost in 4Q17

FY17 headline spike of 36% YoY in associates/JV profits was due to a $15 million negative goodwill recognised in 4Q17. SATS now holds a 25% stake in Evergreen Sky Catering Corporation (ESCC) after acquiring a further 10% stake. The stake in ESCC has now been reclassified from long-term investment to an associate; and the negative goodwill was a result of deemed increase in value of the original investment. Share of profit of associates/JV growth would have been flat at 1.0% YoY, in the absence of this item.

Maintain “Neutral” rating, with higher target price of S$5.08 (previous: S$4.73)

SATS Ltd (SATS) has been growing both organically and inorganically. Our price target gives an implied FY18e forward P/E multiple of 23.2x. We are upbeat on the long-term growth for SATS, but we find valuations unattractive at current level. Investors should look to accumulate on price weakness.

Our narrative for SATS Ltd

SATS will remain a regional food and aviation player, with organic revenue growth driven mainly by air traffic demand. Inorganic growth will mainly come from partnerships in businesses similar to existing ones, as well as adjacent business lines, resulting in investments in Associates & JVs. Capital reinvestment in technology to raise operating leverage and allow the company to scale up.

How our narrative connects to our valuation inputs

• Food Solutions revenue: Mid-single digit growth, slightly lower than Gateway Services, as Food Solutions revenue is a blend of the Aviation (faster growth) and Non-aviation (slower growth).
• Gateway Services revenue: Mid-single digit growth, in line with aviation demand, and slightly higher growth than Food Solutions.
• Aviation revenue: Near term aviation revenue muted at low-single digit growth, but reaching mid-single digit growth in steady state.
• Non-aviation revenue: Lower growth than Aviation revenue, at low-single digit growth that is in line with population growth, as this is mainly Food Solutions.
• Group revenue: FY18 Group revenue expected to be lower YoY because of sale of 4% stake in Asia Airfreight Terminal Company Limited (AAT) and 51% stake in SATS HK Limited (SATS HK). Management guided that the sales would be completed within the next two quarters. Impact to revenue would be ~$45 million, as AAT and SATS HK will be deconsolidated to associated companies.
• Margins: Slight erosion in operating margin in the near-term, but subsequently expanding, due to gains in scale through the use of technology and automation (operating leverage). Compression in operating margin offset by higher contribution from Associates & JVs, resulting in stable net profit margin.
• Associates & JVs: Increasing contribution to the bottom-line as more partnerships are formed. Cash being deployed into forming Associates & JVs, as reflected on the balance sheet and cash flow statement, with cash inflow from dividends.
• Capital reinvestment: Higher than historical average in the next two years, reflecting the push to add technology and automation, then normalising to slightly higher than depreciation.

Discounted cash flow intrinsic valuation

We value SATS using a discounted free cash flow to firm (FCFF) model.