• 2QFY20 revenue beat our expectations, while PATMI fell short of expectations due to declining cargo revenue.
• Food Solutions and Gateway Services revenue grew 4.5% and 12% YoY, with growth showing in both aviation (+8.1%) and non-aviation (+6.5%) food industries.
• New joint venture in Daxing International Airport will expand presence for SATS in China. We estimate it to add $1.5mn to SATS’ bottom line.
• Indian revenue remains subdued due to vacant slots left by Jet Airways.
• Maintain ACCUMULATE with a lower target price of $5.36 (prev. S$5.47). Our PATMI for FY19e is cut by 2.4%.

The Positives

• Food Solutions and Gateway Services revenue grew 4.5% and 12% YoY with growth showing in both aviation (+8.1%) and non-aviation (+6.5%) food industries. Higher Food Solutions revenue is due to increased meal volume growth in Singapore and Japan. Higher gateway services revenue is mainly due to the consolidation of GTR (AirAsia), which contributed $S22.5mn of the S$23.7mn increase. Volume growth in gateway services was offset by lower cargo revenue and lower ship calls (due to maintenance of one cruise ship).
• Accretive acquisitions in China making headway. Greater China revenue has a slight increase of 0.6% YoY due to higher non-aviation food revenue from Kunshan kitchen, offset by a decrease in aviation food revenue from Hong Kong and Taiwan. Meanwhile, SATS entered into 2 joint ventures at Daxing International Airport for ground and cargo handling and inflight catering. It has also completed the acquisition of 50% interest in Nanjing Weizhou Airline Food Corp (NWA). Based on our FY20e P/E assumption of 21.4x, both deals could add S$1.5mn and S$1.3mn to SATS’ bottom line.

The Negatives

• Margin pressure from anaemic cargo volumes. Cargos volumes continue to decline. Volumes were down 3.2% YoY in 2QFY20 due to the Sino-US trade war. Singapore cargo revenue dropped 7% while the decline in Hong Kong more severe. As cargo handling revenue has high operating leverage, PATMI was down 7.6% YoY.
• Indian revenue remains subdued. Indian revenue was down 10.5% YoY in 2QFY20 as the vacant slots leftover from Jet Airways have yet to be filled up. Management mentioned that it would take a few quarters before all the slots are filled. That said, the vacant slots on the Singapore side have been completely filled up by other airlines such as Vistara and Indigo Airlines.

Outlook

Passenger traffic growth is likely to drive volume growth for Gateway Services revenue. However, we do not expect a significant pickup in cargo volumes in the near term. Due to the strong operating leverage of cargo revenue, the bottom line for SATS would be affected in the near term.

However, we expect volume growth to offset cargo revenue as SATS pursue growth opportunities in China via acquisitions and joint ventures. Investments in the central kitchen would improve SATS’ non-aviation food services revenue by fulfilling demand for fast-casual restaurant chains in key cities. Acquisitions in NWA and joint ventures at Daxing International Airport will expand SATS presence in China.

The focus on digitalisation of its supply chain via COSYS+ and the partnership between SATS and DHL will improve efficiency and productivity to cope with pricing pressures for food.

Maintain ACCUMULATE; Lower target price of $5.36

We like the stock for its regional expansion story and growth initiatives. The strong cash flow generation will help sustain the 3.4% dividend yield. We maintained ACCUMULATE with a lower target price of $5.36 due to slower cargo business. Our target price gives an implied FY19e forward P/E multiple of 23.3 times.