Staff Costs Drag 3Q14 Profit

SATS recorded lower food revenue y-o-y, largely due to the Qantas and JPY impact, which was somewhat offset by higher gateway revenue as passenger traffic at Changi Airport continued to grow. Proportionately higher operating expenses dragged down PATAMI growth. While SATS’ long-term outlook is encouraging, we expect near-term headwinds with regards to staff costs. Maintain NEUTRAL and a SGD3.43 TP.

Revenue growth impacted by forex. SATS’ 3Q14 PATAMI slid 8.7% to SGD42.9m, on the back of a 1.1% decline in revenue. The revenue decline was largely due to a dip in food revenue, after Qantas pulled out its longhaul flights from Changi Airport in 1H CY13. On a q-o-q basis, the impact of Qantas’ departure is stabilising, but food revenue is likely to remain under pressure from the depreciating JPY. Gateway revenue is likely to see moderate growth, backed by increasing passenger traffic at Changi Airport.

More efforts to lower operating costs. In order to mitigate the expected rise in manpower costs, SATS is actively looking to raise productivity, through automation and the use of technology. While no further details were given, management highlighted that it will put more efforts into improving productivity, such as building more passenger self-check-in booths at the terminals.

Positive on long-term prospects. SATS’ proposed acquisition of the Singapore Cruise Centre (SCC) is currently under the second review by the Competition Commission. Passenger traffic at the Marina Bay Cruise Centre Singapore (MBCCS) has been growing, although the volume is still small at the moment. Should it become the owner of both cruise centres, SATS would stand to benefit from the growing cruise industry in Singapore. The company, which is also the largest caterer in Singapore, is poised to benefit once the Sports Hub starts operations, likely in 2H CY14. In the near term, higher staff costs could slow profit growth.

Lowering PATAMI estimates. We lower our FY14 PATAMI estimate to SGD194m, from SGD217m. Consequently, we trim our DCF-based TP to SGD3.43 (from SGD3.49). Maintain NEUTRAL.

Sluggish 3Q results and 4Q outlook

• 9M earnings met 76% of FY estimate
  
• Challenging near-term outlook
  
• Hold and FV under review
  

Lethargic 3QFY14 results

SATS Ltd posted a pretty lethargic set of 3QFY14 results. Revenue was flat at S$465.5m, or just shy of the street’s S$472.5m forecast (based on Bloomberg consensus), mainly due to lower food revenue (down 3.9% YoY) arising from the weaker Yen. But earnings slipped 8.7% to S$42.9m, dragged down by the 10.3% fall in operating income, despite seeing 7.4% increase in share of results from Associates/JVs (due to better showing in China and Indonesia). Earnings also missed consensus forecast of S$52.2m by 18%. For 9MFY14, revenue fell 1.3% to S$1352.1m, meeting 76% of our FY14 forecast (72% of consensus), while reported net profit edged 0.6% lower to S$137.8m. Excluding one-off items, core earnings would have been S$139.5m (+0.4%), or about 73% of our full-year estimate (67% of consensus).

Near-term outlook remains challenging

Going forward, SATS notes that the operating landscape remains challenging, given the on-going pressure on airlines’ profitability and rising labour costs. And in the near term, management adds that it only expects modest growth in passenger traffic at Changi Airport and only marginal growth in air freight at best. Nevertheless, it will continue to focus on scaling up its food business and improving connectivity in its gateway business, where it is already the largest food solutions and gateway services company in Asia. SATS also intends to use automation and technology to counter rising manpower costs, which we had already flagged as a longer-term concern and continue to await further clarity on potential cost savings.

Hold rating and FV under review

Given the still-muted outlook, as well as the below-forecast earnings, there is likely to be a negative knee-jerk reaction in SATS’ share price, especially after the 3.2% rebound from the recent S$3.08 low. Due to a change in analyst coverage, we put our Hold rating and S$3.35 fair value under review.

New CEO sets out his vision

• Leverage on technology to ease labour cost pressure, new catering centre required to support Changi Airport expansion
  
• Higher capex could put our DPS forecasts at risk, but we see scope to optimise capital structure
  
• Valuation still attractive at 15x FY15E P/E with dividend yield of 5.0-5.6% over the next three years. Maintain BUY.
  

What’s New

Mr Alex Hungate, the new CEO of SATS, held his first meeting with the analyst community yesterday and shared his strategy for the group. His key points are: 1) cement its presence in Asia, 2) leverage on technology to ease labour cost pressure, 3) take advantage of Changi Airport’s expansion, and 4) raise capex if needed but there would still be room to gear up the balance sheet.

We also visited SATS’s Inflight Catering Centre (ICC) 1 and were impressed with the attention to detail, cleanliness and organised operations at the facility. This has enabled us to better appreciate the synergies between SATS and its non-aviation food business, which processes food before final packaging at the airport.

What’s Our View

We remain positive on the stock as ongoing initiatives to drive productivity will better position SATS for the future. With demand for air travel in the region on the rise, the outlook for its aviation business is bright. Incremental contributions from its non-aviation business will also continue to provide stable income and enhance economies of scale for the group.

Although guidance for a higher capex could put our call for higher dividends over the next three years at risk, we reiterate our view that SATS could enhance shareholders’ returns by optimising its capital structure. At 15x FY15E P/E, valuation remains attractive with the stock offering a dividend yield of 5.0-5.6% over the next three years. Maintain BUY with unchanged TP of SGD4.00 (DCF based: WACC= 7.6%, tg= 1.0%)

New CEO sets out his vision

• Leverage on technology to ease labour cost pressure, new catering centre required to support Changi Airport expansion
  
• Higher capex could put our DPS forecasts at risk, but we see scope to optimise capital structure
  
• Valuation still attractive at 15x FY15E P/E with dividend yield of 5.0-5.6% over the next three years. Maintain BUY.
  

What’s New

Mr Alex Hungate, the new CEO of SATS, held his first meeting with the analyst community yesterday and shared his strategy for the group. His key points are: 1) cement its presence in Asia, 2) leverage on technology to ease labour cost pressure, 3) take advantage of Changi Airport’s expansion, and 4) raise capex if needed but there would still be room to gear up the balance sheet.

We also visited SATS’s Inflight Catering Centre (ICC) 1 and were impressed with the attention to detail, cleanliness and organised operations at the facility. This has enabled us to better appreciate the synergies between SATS and its non-aviation food business, which processes food before final packaging at the airport.

What’s Our View

We remain positive on the stock as ongoing initiatives to drive productivity will better position SATS for the future. With demand for air travel in the region on the rise, the outlook for its aviation business is bright. Incremental contributions from its non-aviation business will also continue to provide stable income and enhance economies of scale for the group.

Although guidance for a higher capex could put our call for higher dividends over the next three years at risk, we reiterate our view that SATS could enhance shareholders’ returns by optimising its capital structure. At 15x FY15E P/E, valuation remains attractive with the stock offering a dividend yield of 5.0-5.6% over the next three years. Maintain BUY with unchanged TP of SGD4.00 (DCF based: WACC= 7.6%, tg= 1.0%)

Inching up

We continue to like SATS for its 4.9% yield, strong balance sheet with net cash of S$270m and encouraging volume growth in Changi Airport. Maintain Outperform.

2Q14’s core net profit was broadly in line with our expectations and consensus’s. 1H14 formed about 45% of our full-year forecast. SATS declared a 5 Scts interim dividend, similar to 1H13. We have raised our target price to S$3.88, after rolling forward to CY15, still based on 17.7x P/E, or +1 s.d. of its five-year mean. Catalysts could come from a rebound of earnings in TFK and stronger dividend payout.

TFK rebound qoq

The yoy weakness in revenue (-2%), already felt in 1Q14 was mainly due to the impact of the weak JPY currency and diversion of Qantas long-haul flights to Dubai from Singapore. Hence, we think it is more relevant to analyse SATS’s qoq performance. Revenue grew 4% qoq in 2Q14, thanks to broad-based growth across gateway and food solutions. TFK’s revenue (contributing about 16% of SATS’s revenue) rose 9% qoq due to 1) stronger outbound traffic and the range-bound SGD/JPY movement. In 1Q14, the SGD/JPY averaged 78.4, but improved slightly to 78.0 in 2Q14

Costs well controlled, margin inched up qoq

EBIT margin improved qoq to 10.3% from to 9.4% in 1Q14, but was weaker yoy (2Q13: 11.2%). Staff cost (about 49% of total expenditure), up 1% yoy, seemed well controlled, although management highlighted that it could weigh on margins given higher foreign manpower levies (SATS’s current foreign/local staff ratio is 1:3). We keep our FY14 EBIT margin of 10.7% (FY13: 10.5%).

Strong operating statistics

Operating statistics in 2Q14 improved for all sectors. Passengers handled grew 4.5% qoq to 11.1m while flights handled grew 2.8% qoq to 33.3k, in line with the high volume at Changi Airport. Unit meals and gross meals produced were up 3% qoq to 5.2m and 6.7m respectively, thanks to new routes introduced by airlines and additional Qantas flights between Singapore and Australia.