Serving yet another strong quarter

SATS registered 2Q11 PATMI of S$45.2m (+10.5% YoY, +2.0% QoQ) on the back of S$401.2m in revenue (+10.7% YoY, +5.0% QoQ). This is in line with our expectations. Excluding the effect of jobs credit of S$6.3m in 2QFY10, PATMI would have risen by 30.6% YoY. 1HFY11 PATMI amounts to S$89.5m while 1HFY10 revenue amounts to S$783.3m, making up 46.8% and 47.0% of our full year forecasts. An interim dividend of 5 S¢ was declared and is payable on 2 Dec. Management remains optimistic on its outlook with particular emphasis on the coming 3Q which is seasonally its strongest. Key challenge going forward would be the rising prices of food. Our DCF-derived fair value of S$3.25 implies an FY11F P/E of 18.7x. Based on last closing, there is a 12.5% upside. Maintain BUY.

2QFY11 revenue grew 10.7% YoY to S$401.2m. Revenue growth was achieved on the back of increased flights handled as well as higher cargo and meal volumes. Non aviation revenue grew 14% to S$164.1m as a result of higher catering revenue stemming from the one-off provision of meals for the Youth Olympic Games (YOG) and higher contribution from its UK operations, particularly in the fruit and chilled ready meals categories. Contributions from its overseas associates rose 51% YoY to S$15.9m boosted by higher volumes in overseas ground handling joint ventures.

Outlook. Management was positive on its coming 3Q which has traditionally been its strongest quarter, due to the holiday and festive season. Revenue from its UK operations are also expected to be stronger in the second half due to seasonality. A key concern that was raised during the analyst briefing was the rising cost of food prices which is expected to remain a challenge going forward.

•Revenue increased by 10.7% to S$401.2mn, while PATMI increased 10.5% to S$45.2mn.

•Long term trend of strong aviation performance still intact as observed from proxy indicators.

•Raw material cost for food business could increase pressure on margins.

•Maintain Buy recommendation with target price of S$3.21.

2QFY11 Results Discussion. The result for this quarter is slightly lower than our expectations. We have observed stronger than estimated top line growth driven by increases in both the Food Solutions & Airport Services segment. Our margin estimates were slightly off and that resulted in an overestimate of S$3.4mn to the shareholder’s profit for the quarter. The operating statistics were also slightly below our expectations. Therefore, we revised our full year profit estimates slightly downwards from S$207.6mn to S$191.5mn.

Key Risk. Increase in raw food prices; consumer preference for LCC reduces scope of airport services; third ground handler at Changi Airport.

Valuation. We roll over the BVPS and EPS estimates and used the blended FY11/12 BVPS of $1.43 and EPS of 17.2¢ to get our revised target price of $3.21. Thus, we maintain our Buy call with forecasted total returns of 15.6% after incorporating dividends payout of 13¢ over the next 12 months.

•Revenue increased by 10.7% to S$401.2mn, while PATMI increased 10.5% to S$45.2mn.

•Long term trend of strong aviation performance still intact as observed from proxy indicators.

•Raw material cost for food business could increase pressure on margins.

•Maintain Buy recommendation with target price of S$3.21.

2QFY11 Results Discussion. The result for this quarter is slightly lower than our expectations. We have observed stronger than estimated top line growth driven by increases in both the Food Solutions & Airport Services segment. Our margin estimates were slightly off and that resulted in an overestimate of S$3.4mn to the shareholder’s profit for the quarter. The operating statistics were also slightly below our expectations. Therefore, we revised our full year profit estimates slightly downwards from S$207.6mn to S$191.5mn.

Key Risk. Increase in raw food prices; consumer preference for LCC reduces scope of airport services; third ground handler at Changi Airport.

Valuation. We roll over the BVPS and EPS estimates and used the blended FY11/12 BVPS of $1.43 and EPS of 17.2¢ to get our revised target price of $3.21. Thus, we maintain our Buy call with forecasted total returns of 15.6% after incorporating dividends payout of 13¢ over the next 12 months.

Expect a seasonally stronger 2H

At a Glance

• 2Q11 within expectations with net profit +11% yoy

• Lower EBIT (-4.2%) was mitigated by higher associate contribution (+51%)

• Stronger 2H on further pick up in activities (air travel, airlines yields/load factor, Daniel’s food business)

• Maintain Buy, S$3.13 TP.

Comment on Results

2Q11 within expectations. 2Q11 net profit was up by 10.5% yoy to S$45.2m on the back of revenue growth of 11% to S$401.2m. EBIT declined by 4% as a result of higher cost of raw materials due to rising food prices. However, this was mitigated by stronger Associates/JV contribution of S$15.9m (+51%) compared to S$10.5m in 2Q10. More gateway activities and better margins from food solutions contributed to the increase in Associate/JV income.

Lower EBIT margins cushioned by better Associates/JV performance. EBIT margins came in lower (-1.6ppt yoy) as prices of raw materials increased 15% from S$94.1m to S$108m. Raw material price increase was mainly due to higher food prices in the form of fruits, dairy, rice, and meat products, affected by poorer harvest and natural disasters. Associates/JV however performed strongly (+51%) with higher gateway activities and better margins from food solutions, mitigating the impact of higher raw material prices.

Recommendation

Expect a seasonally stronger 2H11. We are expecting a seasonally stronger 2H on further pick up in activities on increased air travel, airlines yields/load factor improvement, as well as better contribution from SATS’s Daniel’s food business. However, rising food prices could be a dampener on our earnings estimates although we believe that the effects of rising food prices will be minimised through SATS’s diversified supply base. We are expecting the associates/JV to turn in better 2H performance as air travel improves going forward, and therefore believe that the effects of higher food prices and increased air travel in 2H will cancel out each other. Interim dividend of 5c was declared. Maintain Buy, TP unchanged at S$3.13.

Robust operating data reaffirms 2Q performance

Robust aviation operating data. SATS Ltd’s recent 2QFY11 aviation operating data had lent support to our view that the group is poised to deliver another positive set of quarterly results on 2 Nov. As a note, the group registered improvement across all operating indices in the quarter (both YoY and QoQ), thanks to the recovery in the aviation industry. In particular, unit services grew 5.9% YoY as a result of increased flights from full-service and low-cost carriers. Unit meals also increased by 7.8% YoY on the back of a 10.8% YoY growth in passenger traffic, while cargo throughput rose 7.9% YoY. This is largely consistent with our Sep 17 report that SATS may potentially gain from the continued expansion in industry demand, hence turning in better financial performance for 2QFY11.

Improvements expected to continue, albeit at slower pace. According to the International Air Transport Association (IATA)’s October survey, aviation business conditions had continued to show improvements. While some airlines are starting to turn cautious in view of a modest economic growth in 2011, we note that a still-high 60% of the airlines being surveyed expect further improvement in profitability over the next 12 months (vs. 69.2% in July survey). On the passenger and cargo business front, expectations for further improvements in demand similarly appear to be moderating in light of the economic outlook and the end of restocking activity, but are

still high at 62.5-68.4% (down from 73.9-80.0% in the July survey). As such, we still expect to see further improvements in SATS’ operating performance going forward, albeit at a slower pace (in line with our FY11-12F forecasts).

Maintain BUY with S$3.30 fair value. We continue to like SATS for its growth opportunities, consistently strong operating cashflows and excellent management. The recent launch of the first-ever city check-in and baggage acceptance service with Marina Bay Sands and contract win to provide ground handling services for SIA in Hong Kong are testaments to the group’s ability to innovate quality services and expand its market presence, in our view. We are keeping our DCF-based fair value of S$3.30 pending the release of its 2QFY11 results (cost of equity: 8.5%, terminal growth rate: 1%). At current level, we see an attractive 17.0% upside potential in the stock. As such, our BUY rating on SATS remains.