• 2Q18 revenue in line with our forecast
• Underlying PATMI beat our forecast by 4.4%, due to associates/JVs contribution coming in 19% higher than we expected
• Better volumes was dragged down by cost pressures, resulting in lower EBIT margin
• 6 cents interim dividend declared, unchanged from previous year
• We upgrade to Accumulate with higher target price of $5.23

The positives

• Robust 57% growth from associates/JVs: Overall volumes were up. Management shared that Indonesia and India markets had grown the most. Food Solutions growth came from Evergreen Sky Catering Corp.
• Growth in underlying PATMI, despite lower operating profit: This was due to higher contribution from associates/JVs. This trend of increasing contribution from associates/JVs is to be expected going forwards, as it is a result of the strategy of forming partnerships – either horizontal integration in new geographies (see overleaf) or vertical integration with existing businesses (such as DAFSS SATS).

The negatives

• Lower Food Solutions revenue was due to weaker meal volumes at TFK Corp.: Some customers switched over to the ANA in-flight kitchen, and Delta Air Lines had cut some Tokyo flights. This resulted in 13.2% YoY lower revenue for TFK Corp.
• EBIT margin had compressed as the YoY decline in revenue outpaced the decline in OpEx: The lower OpEx was largely attributable to the deconsolidation of SATS HK which resulted in lower staff costs, company premise and utilities expense. However, licence fees was 24% YoY higher due to cessation of fee rebates at Changi Airport since 1 April.

Outlook

The outlook remains stable to positive. We see credible earnings growth as SATS continues to make investments in associates/JVs. In our previous report, we mentioned the possibility of airlines divesting non-core businesses such as catering and ground handling. SATS has announced partnerships with AirAsia and Turkish Airlines (see overleaf). We view this positively, as they give SATS exposure to markets far larger than the domestic volumes at Changi Airport.

Upgrade to Accumulate (from Neutral); higher target price of $5.23 (previously $5.08)

We incorporate 1H18 results into our FY18e estimates and raise our outlook assumptions for associates/JVs by 12% to 17%. Our target price gives an implied FY18e forward P/E multiple of 23.2x, and forward P/E multiple of 21.7x FY19e earnings. We like the stock for its regional expansion story. SATS is building partnerships today outside of Singapore, that will bear fruit in later years.

Key Takeaways

Management shared some insights to the recent two announcements of overseas ventures with airlines.

Formation of Gateway Services JV with AirAsia

• SATS will take a 50% stake in AirAsia’s Ground Team Red Holdings (GTRH). Following a series of equity swaps and through that 50% stake in GTRH, SATS will have an effective 60% stake in SATS Ground Services Singapore (SGSS) and effective 49% stake in Ground Team Red (GTR) Malaysia.
• SGSS is a newly formed ground handling entity to serve customers at Changi Airport’s Terminal 4 (T4). GTR Malaysia is AirAsia’s ground handling unit and it currently only serves the AirAsia group at 15 airports across Malaysia. The four busiest airports in Malaysia are Kuala Lumpur, Penang, Kuching and Kota Kinabalu.
• With this new access to Malaysia, SATS has an opportunity to serve 88 million passengers in Malaysia, in contrast to the 16 million passengers handling capacity at T4. SATS will grow the business by marketing the ground handling services to other third-party airlines.
• GTRH is likely to begin contributing by the end of 2017 after the transfer is completed.

Memorandum of agreement (MOA) with Turkish Airlines (THY) for Food Solutions JV at Istanbul New Airport

• Istanbul New Airport is slated to become the biggest airport in the world. The First Stage will be able to handle 90 million passengers, and eventually 150 million passengers when completed.
• SATS will share the cost with THY and invest 50% of the CapEx to fit-out the interior of the in-flight kitchen. SATS does not have to incur CapEx for the in-flight kitchen building and will likely pay a lease to the airport authorities.
• THY has 70% share of the base market, Istanbul. Consequently, SATS should have sufficient economies of scale through partnering with the base airline, and can then reach out to other airlines for catering.
• MOA is subject to due diligence and further announcements on the details of the partnership should be made within the next six months.