Expensive caterers

We downgrade SATS to Reduce from Hold with a lower target price of S$2.95, still based on 16x CY15 P/E (5-year mean). Without a major breakthrough in transforming the group, we think that its near-term operations could remain challenging as both topline and margins could be under pressure. FY14 net profit missed our forecast by 11% and consensus by 6% due to weakness in food solutions (weak TFK and lesser meals served). Associates/JVs were also affected by high costs in Hong Kong and weak cargo volume. We cut our FY15-16 EPS by 12-14% and introduce FY17 forecasts. The longer-term outlook (beyond FY17) could be positive, driven by tourism in Singapore and growth in Changi Airport, but valuations (above 5-year mean) look stretched for now.

Weak topline

FY14 revenue slipped by 2% yoy to S$1.787bn, largely on a 5% drop in food solutions (62% of revenue). The key culprits were 1) an 18% drop in contribution from TFK (in line with the c.14% depreciation of ¥ vs. S$), and 2) lower meals produced (-6% yoy to 20.6m units) from the loss of Emirates’s European flights. This is mitigated by higher gateway services (+4.5% yoy) with more passengers and flights handled in Changi Airport. We now expect a 4% yoy rise in revenue in FY15, assuming TFK’s revenue has bottomed and the effects from Emirates’s flights will diminish. Note that TFK was profitable in FY14.

Can’t fight the high staff costs

Food solutions’s operating margin dropped to 12.9% from 13.6% in FY13 and that of gateway services shrank to 2% from 3% in FY13, driven by high staff costs. Overall staff costs rose 3% yoy to S$788m or 44% of total expenses. This pressure is likely to stay given its labour-intensive business model. Benefits from automation may work in its favour over the longer term but it takes time for these incentives to materialise.

Long-term story

SATS declared a final dividend of S$0.08 (total: S$0.13), lower than our expectation of S$0.15. Net cash stood strong at S$228m. SATS is a long-term stock to own but not now, as cost headwinds persist.

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