Widely anticipated award of 3^rd 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.

Widely anticipated award of 3^rd 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.

3rd Ground-Handling Licence at Changi Airport awarded to ASIG

• Long-awaited 3rd Ground Handler announced – ASIG gets 10-year licence

• Impact minimal, but competition expect to stiffen

• Lower market share for SATS has already been factored in

• Maintain HOLD and TP S$2.91 TP.

News:

Changi Airport Group (CAG) announced yesterday that it has awarded the 3rd Ground Handling licence to US based Aircraft Service International Group (ASIG), from a tender exercise which saw proposals from 3 parties. The 10-year licence allows ASIG to provide the full suite of passenger, apron and cargo handling services to airlines operating at Changi Airport. We believe the other notable contender was SIA Engineering. ASIG is a US-based ground handling, fueling, cargo and ancillary services company based in 60 cities with operations in North America, Europe and Asia. It is a wholly-owned subsidiary of BBA Aviation [BBA LN].

Our views:

Stage is set with uncertainty cleared. The award of this 3rd licence has been long awaited, as it was originally announced that the 3rd operator is “expected to commence operations by mid-2010”, in CAG’s media release on 17 Nov 2009, when it first called for tender. Furthermore, there has been market concern that SATS’ contract with SIA could be at risk if SIA Engineering wins the tender.

Impact is minimal at this stage, but more competition ahead is expected. At this point, we see minimal impact on SATS given that ASIG does not yet have any significant presence in Asia, except for a refueling operation in Thailand’s Suvarnabhumi Airport. While we believe ASIG could likely see Singapore as its first significant operation base in Asia, we do note that it would take a while before operations could be scaled up sufficiently. That said, we believe competition is likely to pick up as the new entrant establishes its foothold in this market.

We have already factored in lower market share over the next few years. The re-introduction of a 3rd ground handler is not something new as CAG had first called for submission of plans more than a year and half ago in Nov 2009. As such, we have already factored in an erosion of market share by SATS over the next couple of years. We have assumed that SATS’ market share in passenger handling, flights and cargo handled to drop by c.2ppt per year till 2013.

No changes to our forecasts at this stage. Maintain Hold, TP S$2.91.

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.

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.