No surprises, cost pressures remain

At a Glance

• 4Q/FY11 results within expectations

• 6 Scts final and 6 Scts special dividends proposed

• Trimmed FY12/13F by 5.6%/1.4% on further increases in cost inflation and TFK operations, offset partially by higher JV/Associates contribution

• Maintain Hold, TP adjusted marginally to S$2.91

Comment on Results

4Q/FY11 within expectations. SATS’ 4Q net profit came in at S$50.5m, capping FY11 at S$191.4m (+5.6%), which were within consensus and our expectations. 4Q topline at S$504.9m (+29%) was helped by S$72.6m revenue contribution from recently acquired TFK Corporation (TFK) and organic growth (S$432.2m, +10.7%). EBIT margins fell marginally by 0.3ppt to 10% as staff costs (S$193.7m, +35%) and raw material costs (S$143.9m, +41%) rose by a faster clip on consolidation of TFK’s operations, absence of Jobs Credit and cost inflation. Net profit was helped by strong contribution from its JVs/Associates (S$15.3m, +18%) arising mainly from maiden consolidation from its Air India-SATS JV.

Final/ Special dividend of 6 Scts each, full year at 17 Scts. Management has proposed a final and special dividend of 6 Scts each, bringing full year DPS to 17Scts (interim DPS: 5 Scts) versus FY10’s 13 Scts (5 cts interim, 8 Scts final). This equates to a payout of 98%. With the special DPS payout, management has indicated its desire to improve its capital structure, and return excess cash to shareholders. Even with the payout, the Group is still in a net cash position.

Recommendation

Cost pressures remain; FY12F/13F trimmed by 5.6%/ 1.4%. We expect to see cost pressures continue, especially from higher labour (FY12F: 38.9% of revenue) and raw material costs (28.2%). While management maintained that TFK would not have a material impact on the Group’s performance in FY12F, we expect overall growth to be affected at least partially, especially with the uncertainty over the time period for travel to revert to normalcy post Japan’s quake/ nuclear situation. As such, we have trimmed our earnings marginally by 5.6%/ 1.4% for FY12F/ 13F.

Maintain Hold, TP: S$2.91. We maintain our Hold recommendation with a revised TP of S$2.91, based on the average of PE (14x FY12F) and DCF (WACC: 7.7%, t=1%). We believe its reasonable dividend yield of c.5% should support share price.

SATS Q4 net profit rises 9% to $50.7m

Operating revenue jumps 29.3%; final dividend payout of 12 cents per share proposed

SATS Ltd announced strong operating numbers all round and unveiled a generous final dividend payout of 12 cents per share yesterday.

The January-March quarter saw attributable profits rise 9 per cent to $50.7 million, from $46.5 million a year earlier. Operating revenue for the quarter increased 29.3 per cent to $504.9 million on the back of higher level of activities and the consolidation of Japan-based TFK Corporation (TFK). TFK contributed revenue of $72.6 million.

However, the ground services operator, which counts Japan Airlines as its main customer accounting for 60 per cent of its revenue, took a hit from the March earthquake and tsunami.

For the full year to end-March, SATS’ attributable profit rose 5.6 per cent to $191.4 million, from $181.2 million. Excluding jobs credit of $17.1 million received in the preceding year and the $6 million in M&A expenses, the underlying profit would have increased 20.3 per cent to $197.4 million.

Revenue rose 12.4 per cent to $1.73 billion, from $1.54 billion. The figure could have been higher if not for some exchange rate translation impact.

For example, SATS’ topline would have been $37 million higher if not for a 9 per cent decline in the value of the UK pound versus the Sing dollar.

Associates and joint ventures contributed some $61.2 million for the year, a 46.1 per cent increase from the $41.9 million a year earlier. Gross dividends from associates/joint ventures peaked at $39.5 million for the year, up 58 per cent from the previous year.

The company is paying a total dividend of 12 cents per share, comprising final dividend of 6 cents plus a special dividend of another 6 cents. Together with interim dividend of 5 cents already paid, total dividend for the year is 17 cents per share. This raised the total payout ratio to 98 per cent.

One of the key challenges the company faced, especially during the final quarter, was material cost inflation, though CEO Clement Woon said the company managed to mitigate the full impact of this via a savvy purchasing strategy.

Cost of raw materials surged 41.1 per cent to $143.9 million during the January-March 2011 quarter. Staff costs rose 35.1 per cent to $193.7 million, mainly due to the absence of job credits.

Operating expenditure for the quarter rose 29.8 per cent to $454.7 million, which was higher than the quarterly revenue of $390.6 million SATS chalked up during the January-March 2010 period.

For the full year the rise was 14 per cent to $1.54 billion – a figure equal to the previous full year’s revenue.

Operating margin for the final quarter shrank to 9.9 per cent, from 10.3 per cent, largely due to the absence of the ‘job credits’ effect. For the full year, operating margin narrowed to 10.7 per cent, compared to 12 per cent in FY2009/10.

The company had cash of some $296.1 million at end-March, compared to $195.8 million a year earlier. Its debt/equity ratio rose to 0.12 from 0.02 a year earlier.

Aviation continued to be its biggest business, contributing to 59.2 per cent of revenue. Food solutions accounted for 46.1 per cent of revenue, while gateway solutions was 31.8 per cent, and its UK foods business accounted for 21.5 per cent. Singapore accounted for over 60 per cent of its topline.

Flights handled rose 7.7 per cent during the year, while passengers handled rose 7.2 per cent. The company saw a significant increase in catering demand for the premium ‘front cabins’, which portends better margins and yields.

Going forward, SATS said it will focus on strengthening its Japan operations by leveraging on the combined competencies within its aviation network.

While it maintained that TFK will not have a material effect on its performance in FY2011-12, it added it would remain vigilant over the ’emerging situation in Japan’ and take appropriate actions should the situation deteriorate.

‘TFK and recent joint ventures, AISATS and Adel Abuljadayel Flight Catering (AAFC) in Saudi Arabia underscore SATS’ continuous efforts to strengthen its international network to serve key airline customers in more locations,’ the company said.

AISATS and AAFC are also expected to be earnings accretive in FY2011-12.

In Singapore, SATS said it would mitigate general cost inflation with more productivity enhancement projects.

Noteworthy Share Transaction

• The airline catering / ground handling company, made its first buy-back of its own shares, buying 300,000 shares yesterday at $2.56 each.

• The stock has been under much pressure, dropping from $2.96 on Jan 19th to the $2.53 low two Fridays ago.

• The surge in crude oil, the disasters in Japan have all taken a toll on the airline related sector.

• We would upgrade the stock from Neutral to BUY.

(We have all along preferred SIA Engineering, a former sister company within the SIA Group.)

• Based on the 13 cents dividend paid in respect of ye Mar 2010, yield is 5.1%. Net profit rose 4% in the 9 months to Dec ’10, putting stock on 15x trailing PE.

Increasingly attractive risk-reward proposition

Price weakness presents attractive entry level. Shares of SATS Ltd (SATS) have fallen by 9% (vs. STI -4%) since the group released its 3Q11 results, weighed down by concerns over food price inflation and the threat of heightened competition arising from the entry of a third ground handler at Changi Airport. We believe that these risks have been adequately priced in with the stock trading close to its 52-week low. Not withstanding potential cost pressure stemming from these factors, we believe that investors may have overlooked the positive impact of aviation demand recovery on SATS’ outlook. We forecast a 5.5% growth in FY11 earnings and a further 8.0% improvement in FY12 profits, driven by regional air traffic growth.

Aviation recovery, tourism growth to buoy performance. As a recap, SATS recorded a 6.6% YoY growth in 9M11 revenue to S$1.2b, while net profit increased by 4.5% YoY to S$140.7m. The group’s growth has been driven by higher aviation and non-aviation revenue, further fuelled by improved contributions from overseas associates. Going forward, revenue growth should be supported by the continued recovery of the aviation sector, albeit at a moderating pace. The ICAO (International Civil Aviation Organization) forecasts approximately an 8% growth in Asia Pacific’s air traffic in 2011 and 2012 following an 11% jump in 2010. An additional catalyst could stem from Singapore’s robust tourism landscape, which in 2010 saw a 20% jump in visitor arrivals thanks in part to the opening of the two Integrated Resorts. Singapore’s robust tourism landscape could serve as a meaningful growth driver given that the country accounts for 75% of SATS’ revenue.

Improving risk-reward proposition. We anticipate near term risks stemming from (i) food price inflation, which may elevate operating costs, and (ii) possible knee-jerk reaction upon the announcement of a third ground handler. Nevertheless, SATS has pass-through cost structures in place, which we believe should partially relief higher raw material costs in the medium term. Meanwhile, we believe that the market has priced in the threat of a third ground handler, and an official announcement could possibly lift the share price overhang. Furthermore, we understand that the third license may pertain to a specific segment of services (eg. technical ramp handling) rather than the entire suite of ground handling services. Such a scenario favours SATS as it would lessen the scope of competition. We maintain our BUY rating on SATS and revise our fair value estimate to S$2.87 (previously S$3.31) as we fine-tuned our model. Dividend yield is attractive at 5.5%.

Food for Thought

•Concerns over rising raw material prices is likely to be the main cause of a pullback in the share price

•SATS should be able to pass on cost increase for most of its food business

•Ability to pay out consistent dividends not under threat

•Maintain Buy recommendation with target price of S$3.30.

Dip in share price. We believe that the share price underperformance in the past week could be attributed to two factors: slightly below consensus 3QFY11 results and rising food prices. Prior to the release of results, consensus PATMI estimate was at S$57.3mn (PSR est.: S$51.7mn) as compared to actual results of S$51.2mn. We believe that the quantum of earnings disappointment is not significant as expectations were missed by only 5.2% after adjusting for one off M&A charge of S$3.3mn. We believe that the main cause of a sell down in the stock of SATS is associated with concerns over rising food cost. Hence, we will discuss the implications of rising food prices for SATS in greater detail in this report.

Food Solutions business. Over the past year, Food Solutions business made up 66% of the Group revenue and raw material cost (mainly raw food cost) accounted for 30% of the Group’s total operating cost. After the acquisition of TFK Corporation (consolidated from 4QFY11), Food Solutions business will encompass an even bigger portion of the revenue base of SATS. Therefore, increase in food cost will have a significant impact on the profitability of the Group.