• 3Q18 revenue in line; underlying PATMI came in 3.9% lower than our estimate
• 9M18 revenue and underlying PATMI met 76% and 73% respectively of our full year estimate
• Downgrade to Neutral (from Accumulate); higher target price of $5.33 (previously $5.23)

The Positives

• 8% YoY decrease in staff costs outpaced the 0.2% YoY decrease in revenue. Staff costs is the largest cost component (55% of opex). The decline in staff costs was largely due to the deconsolidation of SATS HK Ltd (SHK), in which 51%-stake was divested in July 2017. The lower staff costs helped to offset the increase from other cost components. However, underlying staff cost had increased.

The Negatives

• Weaker meal volumes at TFK Corp. led to 3.5% YoY lower revenue for TFK. The lower revenue for TFK contributed to the lower Food Solutions revenue. Nonetheless, TFK remains profitable during the quarter. Vietnam Airline had switched over to the ANA kitchen following ANA’s acquisition of a minority stake in the airline; and Delta Air Lines, which is a large TFK customer, had diverted some flights to use Shanghai as a hub instead of Tokyo.
• 2% YoY increase in licence fees and 17.5% YoY increase in other costs. These were due to the cessation of fee rebates and the withdrawal of incentives respectively, by Changi Airport; both effective since Apr 1, 2017. Management does not see Changi Airport reinstating either of them again soon.
• Lower Gateway Services associate contribution. This arises from the deconsolidation of the remaining 49%-stake in SHK to an associate. SHK was loss-making, and now half of the loss is recorded in the associate line.

Outlook

The outlook is positive. Despite the pricing pressure from airlines, we see future earnings growth for SATS, as it continues to make investments and form new partnerships in associates/JVs. SATS is leveraging on its core competencies to tap on growth in passenger and cargo traffic.

Downgrade to Neutral (from Accumulate); higher target price of $5.33 (previously $5.23)

We like the stock for its regional expansion story and pipeline of growth initiatives, but our rating downgrade is on the belief that the market has adequately priced in the growth prospects. Our target price gives an implied FY18e forward P/E multiple of 23.3 times. We would turn buyers of the stock on any opportunistic price weakness.

Key Takeaways

Management shared updates to some of the overseas ventures.

Gateway Services JV with AirAsia

• Operations had commenced on Nov 1, 2017 and final documentation had closed on Jan 4, 2018.
• A fair bit of start-up costs have been incurred.
• Management will provide more details at the end of 4Q FY17/18, after the JV has practically made a full quarter contribution.

Food Solutions JV with Turkish Airlines (THY) at Istanbul New Airport

• Following the signing of the Memorandum of agreement (announced on Oct 18, 2018), negotiations are still in progress; a meaningful announcement could be made in a couple of months
• This is the largest JV announced to date as it involves what could possibly be the largest flight kitchen in the world. For context, 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.
• Management expects a construction time of two years for the kitchen. The building will be owned by the airport, and SATS will lease the building. Capex will only be for the equipment in the kitchen.

Cargo concession at Mumbai Airport

• SATS had announced on Dec 29, 2017 that it had won a cargo handing concession in Chhatrapati Shivaji International Airport (CSIA) in Mumbai, India, through a joint bid with Cargo Service Centre India Private Limited (CSC).
• Mumbai is an important hub in India which handles 900 tonnes of cargo/year
• The opportunity for SATS is to redevelop the cargo facility at the airport.