No reprieve anytime soon

Falling margins and profit contraction in 3Q12 reaffirm our bearish stance on SATS. Do not expect a reversal of fortune anytime soon. The disposal of Daniels implies the loss of an income stream, while start up costs for ICT will further eat into profits.

9M12 earnings met our expectations at 73% of FY but fell short of consensus at just 69%. We cut our FY12-14 EPS by up to 8% and our TP, still based on 9.1x CY13 P/E, slips accordingly. Maintain Underperform as SATS’s lackluster outlook does not deserve its current rich valuation.

Shrinking margins

We foresee that SATS will continue to succumb to margin pressure over the next few quarters. Margin contraction continued to plague the group in 3Q12 with net profit margin falling to its lowest level in eight years, wiping out revenue growth and resulting in a 25% yoy decline in profits. The group blamed this on higher raw material costs, energy and other expenses. Poor associates’ performance resulting from weak cargo demand further dampened earnings.

Tepid outlook

We anticipate further margin pressure over the next few quarters arising from start-up costs needed for the International Cruise Terminal, mainly on the hiring front. Furthermore, the lacklustre aviation industry outlook implies subdued pricing power for SATS. Interestingly, management cited this as a more pressing factor weighing its pricing power rather than competition from new entrant ASIG, which according to management has not captured any market share to date.

Rich valuations unjustified

We cut our FY12-14 EPS by up to 8% to reflect higher operating costs. Recent results certainly do not justify a more positive view. Despite a challenging outlook, SATS has rallied in-line with the market and is trading near its 8-year P/E and P/BV mean. We believe that its rally will soon peter out as results show that earnings risks have yet to be fully reflected.

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