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Cost management start to yield results

• Results above expectations
  
• Cost management still a key focus\
  
• Increase FV; maintain HOLD
  

3QFY15 PATMI jumped 25.2% YoY to S$53.7m

SATS reported a good set of 3QFY15 results on the back of disciplined cost management and favourable business mix which pushed up overall operating margins. While revenue declined 3.2% YoY to S$450.7m, PATMI saw a 25.2% jump to S$53.7m. The lower revenue is largely attributable to the weaker result from its Japan subsidiary, TFK, resulting in a 7.2% YoY drop in its 3QFY15 Food Solutions (FS) segment revenue. Gateway Services (GS) 3QFY15 revenue, however, saw a 3.5% increase as SATS continue to gain market share in cargo handling business in Singapore. The shift in business mix away from FS segment resulted in a 13.1% drop in 3QFY15 raw materials expenses. Lower staff costs also helped improve profitability. SATS 9MFY15 PATMI came in above expectations with a 4.6% YoY increase, as it formed 79.6% and 78.4% of the street and our FY15 forecasts.

Cost management a key focus amid challenging outlook

Management reiterated strategy is still to focus on managing costs and improving productivity, which include a dynamic roster system, and investing in technology to increase operating leverage through automation, which requires fewer employees and hence lower staff expenses. Also, with the FS segment revenue declining on higher LCCs’ flight cancellations, the expected shift in business mix towards more cargo handling of higher margins (which makes up ~33% of GS segment revenue) is likely to continue, especially for pharmaceutical cargos. In addition, while share of profits from overseas GS associated/JV companies is likely to continue to face volume and price pressures, we expect lower energy costs and FS segment account rationalisation to improve profitability. We also expect TFK’s revenue to still be muted due to overcapacity of caterers in Narita Airport.

Decent dividend expected; maintain HOLD

We continue to think SATS will maintain a decent level of dividend pay-out (~90%). Incorporating 3QFY15 results and the above factors, our FY15/16F forecasts increase by 5.1% and 5.7%, respectively. Based on 16.5x FY16F PER (5-year mean), our FV increases to S$2.98 (previous: S$2.92). Maintain HOLD.

Slow start

• 1Q15 results slightly below estimates, dragged by higher costs and lower JV/associates contribution
  
• Muted outlook due to overcapacity in the aviation sector and higher costs
  
• Strong net cash position; 4.1% dividend yield to support share price
  
• Maintain HOLD with TP adjusted slightly lower to S$2.90
  

Highlights

1Q15 earnings slightly below. 1Q15 earnings (S$43.3m, -6% yo-y) was slightly below our expectations, making up 22% of our full year forecast of S$196m. Flat revenue (S$435.2m, +0.2% y-o-y) along with increases in operating costs (+0.4%) and lower JVs/associate income (S$10.4m, -17%) led to the slower earnings Growth in gateway services revenue (+2% y-o-y), was dragged by lower food revenue (-0.9% y-o-y). Higher staff costs (+3%) resulted in a decline in operating margins (-0.3ppts, 9.1%), while lower regional cargo volumes led to a drop in JVs/associate income.

Strong net cash and free cash flow generation. Despite slower than expected earnings, SATS’ balance sheet and cash generating ability remained strong. Net cash increased to S$280m (from S$227m in 4Q14) while its operations generated S$31m in free cash flow which amounted to 72% of net income.

Our View

Lackluster outlook. We believe SATS’ growth outlook will be soft as the regional aviation market continues to see overcapacity. The rise in the number of LCCs will also undermine utilisation at its flight kitchens and growth in food solutions revenue. In addition, we see higher staff cost increases as dampeners to margin and earnings growth. We look forward to SATS growing its revenue streams away from aviation, into institutional catering (i.e. at Sports Hub) and maritime gateway services (i.e. at Marina Bay Cruise Centre).

Expect share price to be supported by dividend yield. Based on our FY15F DPS estimate of 13 Scts, SATS’ share price currently offers 4.1% dividend yield. Although earnings were slightly below our expectations, we do not believe this will undermine SATS’ DPS payout for this year. We therefore believe that SATS’ share price will be well supported by its dividend yield.

Recommendation

Maintain HOLD with lower S$2.90 TP. Following the slower than expected 1Q15 earnings, we trim our FY15F/FY16F earnings marginally by 1-2%. This resulted in a lower TP of S$2.90, based on average valuations using DCF (WACC 7.5%, t=1.5%) and PE (16x blended FY15F/FY16F EPS). Maintain HOLD.

Uninspiring 1QFY15 results

• 1QFY15 results below forecasts
  
• Focus on creating operating leverage
  
• Maintain HOLD
  

1QFY15 results below expectations

SATS’s 1QFY15 results came in below our expectations. Revenue increased 0.2% YoY to S$434.5m, or 6.4% below our forecast. Food Solutions revenue dropped by 0.9% to S$262.7m due to weaker performance from subsidiary TFK. The drop is smaller compared to the previous quarter’s 5.7% as the effect of Quantas’ move to Dubai from Changi Airport is absent in the current quarter’s YoY comparison. Gateway Services revenue increased by 2.0% to S$171.2m, which we deem to be largely in line with the 2.5% growth in flights handled in Singapore. Despite top line growth, PATMI dropped 6.3% YoY to S$43.3m, which is 4.6% below our estimate. This is due to: 1) lower operating margin (-0.3ppt to 9.1% in 1QFY15) mainly caused by higher staff costs, and 2) lower contributions from associates and JVs (-16.8% YoY to S$10.4m in 1QFY15) on the back of muted Asian cargo volumes.

Creating operating leverage is multi-year process

Management guided that headcount reduction will continue as processes are made more efficient. Capex spending is rising (S$14.2m in 1QFY15 vs. S$12.8m in 1QFY14) and will stay elevated. Additionally, airlines at existing Changi Airport terminals are still switching to self-check-in processes, eventually reducing the need for staff. With regional airlines struggling, we think the cost-saving switch will come in the foreseeable future. We note that initiatives to create operating leverage are multi-year processes which involve clients as well. Thus, we are not too worried about the current fall in operating margin.

M&A to tap on regional air traffic growth

Management said they are on the lookout for M&A opportunities to grow inorganically. SATS is well-poised to do so with a healthy net cash balance of S$270m and interest coverage ratio of 99x as of Jun-14. This is likely a key source of overseas growth going forward, to enjoy economies of scale in a capital intensive business. Incorporating the latest results and retaining a 20x FY15F PER, we derive a lower TP of S$3.20 (previous: S$3.23). Maintain HOLD.

Uninspiring 1QFY15 results

• 1QFY15 results below forecasts
  
• Focus on creating operating leverage
  
• Maintain HOLD
  

1QFY15 results below expectations

SATS’s 1QFY15 results came in below our expectations. Revenue increased 0.2% YoY to S$434.5m, or 6.4% below our forecast. Food Solutions revenue dropped by 0.9% to S$262.7m due to weaker performance from subsidiary TFK. The drop is smaller compared to the previous quarter’s 5.7% as the effect of Quantas’ move to Dubai from Changi Airport is absent in the current quarter’s YoY comparison. Gateway Services revenue increased by 2.0% to S$171.2m, which we deem to be largely in line with the 2.5% growth in flights handled in Singapore. Despite top line growth, PATMI dropped 6.3% YoY to S$43.3m, which is 4.6% below our estimate. This is due to: 1) lower operating margin (-0.3ppt to 9.1% in 1QFY15) mainly caused by higher staff costs, and 2) lower contributions from associates and JVs (-16.8% YoY to S$10.4m in 1QFY15) on the back of muted Asian cargo volumes.

Creating operating leverage is multi-year process

Management guided that headcount reduction will continue as processes are made more efficient. Capex spending is rising (S$14.2m in 1QFY15 vs. S$12.8m in 1QFY14) and will stay elevated. Additionally, airlines at existing Changi Airport terminals are still switching to self-check-in processes, eventually reducing the need for staff. With regional airlines struggling, we think the cost-saving switch will come in the foreseeable future. We note that initiatives to create operating leverage are multi-year processes which involve clients as well. Thus, we are not too worried about the current fall in operating margin.

M&A to tap on regional air traffic growth

Management said they are on the lookout for M&A opportunities to grow inorganically. SATS is well-poised to do so with a healthy net cash balance of S$270m and interest coverage ratio of 99x as of Jun-14. This is likely a key source of overseas growth going forward, to enjoy economies of scale in a capital intensive business. Incorporating the latest results and retaining a 20x FY15F PER, we derive a lower TP of S$3.20 (previous: S$3.23). Maintain HOLD.