SATS likely to face rising cost pressures

This prompts some analysts to downgrade the stock; other concerns include integration of new acquisition TFK Corp

GROUND-handler SATS is expected to face intensifying cost pressures from rising food prices and potential competition from the entry of a third ground-handler at Changi Airport, prompting some analysts to downgrade the stock this week.

For the third quarter ended Dec 31, 2010, SATS posted a 4.1 per cent year-on-year drop in net earnings to $51.2 million on the back of higher costs.

Revenue rose marginally, up 1.5 per cent to $440.9 million, as gains from its aviation revenue were offset by a fall in non-aviation revenue, which was hurt by the weaker British pound as well as a three-week cut in the accounting period for its UK-based food manufacturer Daniels Group.

Analysts flagged worsening inflationary pressure on food materials as a key risk.

‘Although management strives to pass on cost increases to its customers and broaden its food sources, we believe there would likely be a time lag,’ DBS Group Research said in a research note.

Another concern is the integration of its latest acquisition, TFK Corporation. Last year, SATS announced that it was acquiring a 50.7 per cent stake in Japan- based airline caterer TFK from Japan Airlines International Co Ltd (JALI) for 7.8 billion yen (S$121.55 million). The acquisition was completed in late December.

‘Urgent action needs to be taken on broadening TFK’s customer base beyond JAL and to rein in the cost structure, especially where wages are concerned. If all goes well, management expects TFK to be profit neutral in FY12 before turning earnings accretive in FY13,’ wrote Kim Eng analyst Gregory Yap in a research note.

Kim Eng downgraded its call on the stock to ‘hold’, trimming its target price from $3.48 previously to $2.93, while CIMB maintained its ‘underperform’ rating on SATS, with a target price of $2.42.

DBS Group Research also called a ‘hold’ on the stock and cut its price target from $3.13 to $2.94, pointing out that there is still uncertainty as to how SATS will be impacted by the entry of a third ground handler at Changi in the first quarter of this year.

SIA Engineering Company (SIAEC), a part of the Singapore Airlines group, is among those in the running, which could mean stiffer competition if SIAEC bags the licence.

However, Phillip Securities Research remained upbeat on the stock, maintaining a ‘buy’ call with a target price of $3.30.

It said that while SATS has to contend with rising food prices and the depreciating British pound, it expects SATS to benefit from the influx of tourists into Singapore as the travel industry continues to register growth.

CIMB also noted that SATS has gained a 10 per cent market share for technical ramp handling at Changi since it was granted a full apron handling licence in May last year.

The counter closed four cents lower at $2.76 on Wednesday.

SATS likely to face rising cost pressures

This prompts some analysts to downgrade the stock; other concerns include integration of new acquisition TFK Corp

GROUND-handler SATS is expected to face intensifying cost pressures from rising food prices and potential competition from the entry of a third ground-handler at Changi Airport, prompting some analysts to downgrade the stock this week.

For the third quarter ended Dec 31, 2010, SATS posted a 4.1 per cent year-on-year drop in net earnings to $51.2 million on the back of higher costs.

Revenue rose marginally, up 1.5 per cent to $440.9 million, as gains from its aviation revenue were offset by a fall in non-aviation revenue, which was hurt by the weaker British pound as well as a three-week cut in the accounting period for its UK-based food manufacturer Daniels Group.

Analysts flagged worsening inflationary pressure on food materials as a key risk.

‘Although management strives to pass on cost increases to its customers and broaden its food sources, we believe there would likely be a time lag,’ DBS Group Research said in a research note.

Another concern is the integration of its latest acquisition, TFK Corporation. Last year, SATS announced that it was acquiring a 50.7 per cent stake in Japan- based airline caterer TFK from Japan Airlines International Co Ltd (JALI) for 7.8 billion yen (S$121.55 million). The acquisition was completed in late December.

‘Urgent action needs to be taken on broadening TFK’s customer base beyond JAL and to rein in the cost structure, especially where wages are concerned. If all goes well, management expects TFK to be profit neutral in FY12 before turning earnings accretive in FY13,’ wrote Kim Eng analyst Gregory Yap in a research note.

Kim Eng downgraded its call on the stock to ‘hold’, trimming its target price from $3.48 previously to $2.93, while CIMB maintained its ‘underperform’ rating on SATS, with a target price of $2.42.

DBS Group Research also called a ‘hold’ on the stock and cut its price target from $3.13 to $2.94, pointing out that there is still uncertainty as to how SATS will be impacted by the entry of a third ground handler at Changi in the first quarter of this year.

SIA Engineering Company (SIAEC), a part of the Singapore Airlines group, is among those in the running, which could mean stiffer competition if SIAEC bags the licence.

However, Phillip Securities Research remained upbeat on the stock, maintaining a ‘buy’ call with a target price of $3.30.

It said that while SATS has to contend with rising food prices and the depreciating British pound, it expects SATS to benefit from the influx of tourists into Singapore as the travel industry continues to register growth.

CIMB also noted that SATS has gained a 10 per cent market share for technical ramp handling at Changi since it was granted a full apron handling licence in May last year.

The counter closed four cents lower at $2.76 on Wednesday.

SATS Q3 earnings dip to $51.2m

4.1% drop due to lower non-aviation revenue and rising expenditures

SATS Ltd saw flattish topline growth and a dip in net profit for the October-December 2010 third quarter due to smaller contributions from its non-aviation segment and rising expenditures. Net earnings for the three months dipped 4.1 per cent to $51.2 million, from $53.4 million as costs rose some 3.3 per cent to $388.7 million. Contributing to the higher expenditure was some $3.3 million in professional fees for M&A activities.

Revenue was flattish at $440.9 million, compared to $434.3 million a year earlier due to a 5.7 per cent dip in non-aviation revenue to $194.1 million, largely at its UK-based Daniels brand (denominated in the weakening UK sterling), which offset its 8.2 per cent gain in aviation revenue to $244.1 million.

The company had cash of some $166.7 million at the end of December 2010, up from $138.4 million a year earlier.

The results translated into a nine-month earnings of $140.7 million, versus $134.7 million for the April-December 2009 period.

Revenue for the nine months came to $1.22 billion, 6.6 per cent up from $1.15 billion a year earlier.

The company said that underlying operating profit would have risen 7.1 per cent to $137.6 million after adjusting for M&A expense and the $15.6 million jobs credit it received the year before. Contribution from overseas associates and joint ventures rose by 58.8 per cent to $45.9 million for the nine months.

It was up 65 per cent at $15.3 million, from $9.3 million, for the October-December third quarter.

In the quarter, the group also completed its takeover of TFK, in which it has a stake of 53.8 per cent.

The company now gets almost 42 per cent of its revenue from the non-aviation side, while almost 58 per cent comes from aviation. In terms of business breakdown, 21.9 per cent comes from its UK food business, 33.4 per cent from gateway services at airports, and 44.1 per cent from food services.

SATS expects moderate growth for the current fourth quarter amid a recovery in the aviation sector. But it warned of inflationary impact on raw materials for food.

'Inflationary pressure on food materials is expected to worsen,' it said. 'Hence, managing food costs remains a key focus of management. Over in the UK, food inflation and the increase in value added tax to 20 per cent from January 2011 would potentially affect retailers.'

It said that Daniels management in the UK would monitor the situation closely and broaden its food sources.

Broad-based growth expected in 3QFY11

Airport Services to show positive performance. We expect SATS Ltd to close its 3QFY11 on a positive note, driven by broad-based growth across its business segments. Based on latest statistics from the Singapore Tourism Board, the number of visitor arrivals to Singapore has continued to show robust performance, with a 16.1% YoY growth in Nov, thereby marking its 12th consecutive months of record arrivals. On a global scale, the air transport operating statistics as published by IATA has been equally healthy, with passenger and freight traffic registering 8.2% and 5.4% YoY growth in Nov, respectively. While the adverse weather conditions in Europe and US may have caused some setback to the year-end holiday season, we believe it has limited impact on SATS’ financial performance. As such, we expect its Airport Services segment to show positive YoY growth in 3QFY11.

Daniels Group to provide boost to Food Solutions. On its Food Solutions segment, we expect Daniels Group to give further boost to its UK operations as it enters into the seasonally stronger 2H (due to cold season). While pressure on food pricing, especially in Europe, is expected to continue, we note that SATS has in place several measures (e.g. secure longer contracts for some commodities) to tackle the inflationary pressures.

Acquisition of TFK Corporation a positive. We are also positive on SATS’ recent cash acquisition of Japan Airlines International’s 50.7% stake in TFK Corporation for JPY7.8b (~S$122m, funded through debt). We agree with management that TFK will provide SATS with synergies to its airline catering operations and access into Japanese airline catering market, especially at Narita and Haneda Airports, which are expected to see significant increase in arrival/ departure slots in the next few years. As a note, the purchase price implies a 9.4x EV/EBITDA based on its FY10 results, a discount to an average of 11.6x in similar transactions involving Japanese food/ food services companies over the last three years. For its FY10 ended Mar, it attained revenue and EBITDA of ~S$353m and S$27m respectively (forming 22.9% and 9.8% of SATS’ FY10 reported figures).

Retain BUY. We keep our FY11 forecasts intact pending the release of its 3QFY11 results but raise our FY12 revenue by 4.3% to factor in TFK’s contribution in the next fiscal year. We maintain our positive view on SATS’ growth prospects, as it is likely to benefit from continued growth in the tourism industry, and increased penetration in hospitality and healthcare sectors. Maintain BUY with S$3.31 fair value (unchanged).

Completes acquisition of 50.7% stake in TFK Corporation

•Purchase price values TFK at Enterprise Value of ¥16.3bn (≈S$254mn)

•EV/EBITDA of 9.4X not expensive

•Revised earnings up by 0.6%, 4.4% & 4.6% for FY11E, FY12E and FY13E respectively.

•We estimate that TFK will contribute 18.4% of Group sales, which could breach the S$2bn milestone in FY12E.

•Maintain Buy recommendation with revised target price of S$3.48.

Completion of the acquisition of TFK. SATS announced that they had completed the acquisition of the Japan Airlines International Co Ltd’s (JALI) 50.7% stake in TFK Corporation (TFK). Although the acquisition is for a 50.7% stake in TFK, SATS effectively has voting rights of 53.8% of the company as 5.8% of the acquisition is held as treasury shares by the company.

More details revealed about TFK. The purchase price of the acquisition values TFK at an Enterprise Value (EV) of ¥16.3bn (≈S$254mn). For the financial year ended 31 Mar 2010, TFK achieved Earnings before Interest, Tax, Depreciation & Amortization (EBITDA) of ¥1.7bn (≈S$27mn) which translates to an EV/EBITDA multiple of 9.4X. The valuation implied is below the EV/EBITDA of similar acquisitions over the last 3 years that have an average multiple of 11.6X. SATS also revealed that the revenue of TFK for FY10 is ¥22.6bn (≈S$353mn). Based on our estimates, TFK is marginally profitable at EBITDA margin of 7.5% for FY10. Despite the strong cash of SATS (Cash & Equivalent as of 30 Sep 10: S$182.8mn), 100% of the acquisition cost (S$122mn) will be fully funded with debt.

A proxy to growth at Narita & Haneda airport. SATS stated in the initial acquisition announcement that the Ministry of Land Infrastructure, Transportation and Tourism of Japan had indicated that they intend to increase the no. of slots at Narita & Haneda Airports by 80k and 87k respectively to 300k and 447k slots by 2014. This works out to an estimated annual growth of 5-7% for Narita and 4-5% for Haneda Airport.

Valuation. We used a blended valuation of P/E, P/B & FCFE to get our revised target price of $3.48. Thus, we maintain our Buy call with forecasted total returns of 27.1% after incorporating dividends payout of 13￠ over the next 12 months.