SATS – Phillip

Gearing towards an optimal capital structure

Revenue increased by 12.4% to S$1.7bn, PATMI increased 5.6% to S$191mn.

Marginal loss at TFK despite low volume and disruptions

Move towards optimal capital structure to reduce cost of capital

Adjusted earnings estimates by +1.6%/-1.7% for FY12/FY13E; introduce FY14E

Maintain Buy recommendation with revised target price of S$3.41.

FY11 within our expectations. SATS’s PATMI for FY11 was in line with our expectations to record a 5.6%y-y increase to S$191.4mn. SATS also consolidated the results of TFK Corp for the first time in 4QFY11 (Revenue: S$72.6mn; Operating loss: S$1.6mn). TFK’s losses for the quarter are fairly small, in our opinion, considering the disruptions to air traffic experienced in the month of March. Despite the translational effects of a weaker GBP against SGD, the UK business managed to record a marginal growth in revenue contribution, which we estimated to be an 8%y-y growth in local currency terms. The core Airport Services business for SATS continues to grow in tandem with the higher traffic at Changi Airport. However, despite the double digit growth in sales, operating profits were flat y-y, due to the changing cost profile for the company.

FY10 FY11 y-y (%) Remarks

Inflation outlook looks manageable, for now

Previously, we had discussed extensively on the effects of food price inflation on SATS. For now, the operating cost profile for 4Q seems to indicate that the cost pressures on raw material cost is manageable. Raw material cost continues to make up c.40% of Food Solutions Revenue and had declined sequentially. However, this figure is slightly distorted by the contributions of TFK in 4QFY11 and we will continue to monitor for SATS’s ability to pass on the higher cost to their customers.

Inflight catering seems to be able to pass on the higher cost?

Recall that some of SATS’s inflight catering contracts with airlines have an embedded inflation peg to its price. Our ASP estimates suggest that SATS was able to raise their unit price to combat the rising food costs. The ASP for their inflight catering business in Singapore trended upwards to S$21/unit meal in 4QFY11. We see this as a sign of the inflation peg taking effect or a better product mix (higher value meals) in the quarter. Either way, it seems to indicate that SATS is able to lift their prices to offset the inflationary pressures.

TFK is not likely to contribute in the near term

TFK’s financial statements were consolidated into SATS’s results for the first time in 4QFY11. Management disclosed that TFK recorded revenue of S$72.6mn and operating loss of S$1.6mn. We translated this value to arrive at an estimate of ¥4.68bn, which is 21% of the revenue attained in FY10. TFK is currently operating at 50% capacity and we believe that the key to TFK being earnings accretive would be to increase its sales volume. However, following the Earthquake on 11th Mar, air travel to Japan had been adversely affected. For example, SIA had disclosed that traffic to Japan declined by c.30%, as compared to pre-crisis levels. We believe that the near term outlook for TFK is negative with poor passenger confidence in air travel to Japan. Hence, we expect TFK to report at least another two quarters of operating losses, before they can be earnings accretive to SATS.

SG Aviation growth continues in 4QFY11

SATS’s operating statistics showed that the Aviation business in Singapore continued its path of growth in 4QFY11. We opine that SATS’s aviation business in Singapore has the best competitive position amongst the various segments. With its dominant position and stable business, the segment is able to generate strong free cashflows to finance its acquisitions and return cash to shareholders.

Towards an optimal capital structure

SATS surprised us by proposing significantly higher dividend payout for FY11 (Special + Final: 12¢). It was surprising as we had expected management to be more conservative in their gearing, as the company recently raised >S$120mn of debt to finance the acquisition of TFK Corp. SATS is likely to tap the debt market to finance any further acquisitions and would gear up towards a slightly more leveraged capital structure. In our opinion, this would significantly reduce the company’s cost of capital and should not have an impact on the interest coverage with strong cashflows contributions from the stable business in Singapore. In view of the likely change in capital structure, we estimate SATS to have a long term WACC of 7.6%.

Valuation

We used a DCF model (WACC: 7.6%; terminal g: 1%) to arrive at our target price of S$3.41. Our target price implies a FY12E P/E of 19X, which is at the top end of its historical P/E range. With significant changes in capital structure and varied risk profile following the acquisitions in recent years, we believe that the historical valuation range could no longer be a good guide for SATS’s future valuation. After including forecasted dividends of 17.3¢ over the next 12months, we expect total return of 34.8%. Hence we keep our Buy call on SATS.

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