SATS – OCBC

Increasingly attractive risk-reward proposition

Price weakness presents attractive entry level. Shares of SATS Ltd (SATS) have fallen by 9% (vs. STI -4%) since the group released its 3Q11 results, weighed down by concerns over food price inflation and the threat of heightened competition arising from the entry of a third ground handler at Changi Airport. We believe that these risks have been adequately priced in with the stock trading close to its 52-week low. Not withstanding potential cost pressure stemming from these factors, we believe that investors may have overlooked the positive impact of aviation demand recovery on SATS’ outlook. We forecast a 5.5% growth in FY11 earnings and a further 8.0% improvement in FY12 profits, driven by regional air traffic growth.

Aviation recovery, tourism growth to buoy performance. As a recap, SATS recorded a 6.6% YoY growth in 9M11 revenue to S$1.2b, while net profit increased by 4.5% YoY to S$140.7m. The group’s growth has been driven by higher aviation and non-aviation revenue, further fuelled by improved contributions from overseas associates. Going forward, revenue growth should be supported by the continued recovery of the aviation sector, albeit at a moderating pace. The ICAO (International Civil Aviation Organization) forecasts approximately an 8% growth in Asia Pacific’s air traffic in 2011 and 2012 following an 11% jump in 2010. An additional catalyst could stem from Singapore’s robust tourism landscape, which in 2010 saw a 20% jump in visitor arrivals thanks in part to the opening of the two Integrated Resorts. Singapore’s robust tourism landscape could serve as a meaningful growth driver given that the country accounts for 75% of SATS’ revenue.

Improving risk-reward proposition. We anticipate near term risks stemming from (i) food price inflation, which may elevate operating costs, and (ii) possible knee-jerk reaction upon the announcement of a third ground handler. Nevertheless, SATS has pass-through cost structures in place, which we believe should partially relief higher raw material costs in the medium term. Meanwhile, we believe that the market has priced in the threat of a third ground handler, and an official announcement could possibly lift the share price overhang. Furthermore, we understand that the third license may pertain to a specific segment of services (eg. technical ramp handling) rather than the entire suite of ground handling services. Such a scenario favours SATS as it would lessen the scope of competition. We maintain our BUY rating on SATS and revise our fair value estimate to S$2.87 (previously S$3.31) as we fine-tuned our model. Dividend yield is attractive at 5.5%.

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