SATS – Phillip

Widely anticipated award of 3rd ground handling licence

New entrant has extensive experience and presence in US and Europe

Market size at Changi has room for growth

Not material news as it is widely anticipated by the market

Maintain Buy recommendation with target price of S$3.41.

CAG awards 3rd ground handling licence

Changi Airport Group (CAG) announced the award of a 3rd ground handling licence to Aircraft Services International Group (ASIG). The licence for ASIG will be for 10yrs, which is at the top end of the proposed tenure of 5-10yrs. ASIC would be licensed to provide the full suite of passenger handling, apron handling and cargo handling services that is similar to the services provided by incumbent SATS and CIAS. The award of this licence had been widely anticipated by the market, after the exit of Swissport in early 2009. However, the proposed commencement of operations for the successful bidder had been delayed for a couple of times, originally expected to be in mid-2010, but subsequently to 1Q2011. In the announcement by CAG, there was no indication of the expected commencement of operations for ASIG.

ASIG

ASIG, subsidiary of London listed BBA Aviation PLC, is a US-based aviation service provider with significant presence in US and Europe. In Asia, ASIG only provides fuelling services in Bangkok, Thailand. ASIG had been in the business of providing ground handling services since 1947 and handles more than 4mn flights/yr across its network

What is at stake for SATS?

The gateway services segment comprises of 32% of revenue and 28% of operating profits for SATS in FY11. SATS handled 103.7k flights, 35.4mn passengers and 1,495k tones of cargo/mail in FY11, which was a growth of 6.2-7.2% over FY10.

Market size at Changi Airport

Changi Airport handled 42mn passenger movement in 2010, a growth of 13% over 2009. There is certainly room for growth at the airport, particularly in the budget segment, which had seen strong demand in recent years. We estimate that the airport is currently operating at c.57% of its maximum capacity.

How does this change the scene?

We opine that the most important success factor for the new entrant would be to achieve sufficient scale of operation. Swissport’s attempt to undercut the competitors resulted in an average decline in ground handling rates of 15% since they commenced operations. However, continued losses was followed by the economic slowdown and resulted in the exit of Swissport in early 2009. We do not think that ASIG will pose an immediate threat to SATS for the following reasons:

• Long term contracts with key customer. SATS currently has a ground handling contract with SIA till Sep 2012, followed by an automatic extension till Sep 2014.

• Unlikely to compete solely on rates. From the experience of Swissport, it is unlikely that ASIG would pursue a strategy of aggressively cutting rates. However, we believe that the incumbents would likely keep their rates competitive in order to retain their airline customers. Furthermore, with the abrupt exit of Swissport, airlines could be wary of engaging services from a new entrant.

• Advantage with scale and scope. SATS currently has a market share of 80% at Changi Airport and would certainly enjoy better economies of scale than the new entrant. Furthermore, SATS also provides Inflight catering services and had been awarded the technical ramp handling licence last year. This would allow SATS to provide a more holistic range of services to its customers.

Conclusion & Valuation

We kept our estimates unchanged as we had already factored in flat ground handling rates into our forecasts for the next 5yrs. We believe that the award of this 3rd ground handling licence had been widely anticipated by the market and is not expected to have a material impact on SATS. In valuing the stock of SATS, we used a DCF model (WACC: 7.6%; terminal g: 1%) to arrive at our target price of S$3.41. After including forecasted dividends of 17.3¢ over the next 12months, we expect total return of 35.9%. Hence we keep our Buy call on SATS.

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