Lower Revenue In 2Q14

SATS’ 2Q14 revenue dipped 2% y-o-y to SGD452.1m, largely due to lower food revenue. Operating margins remained under pressure, leading to a 3% y-o-y decline in PATAMI. The expected y-o-y weakness in the JPY would mean lower revenue contribution from TFK. SATS’ share price has risen 9% over the past month and our DCF-based TP of SGD3.49 now presents a 3% upside. Downgrade to NEUTRAL.

Lower food revenue due to TFK and Qantas. The lower load factor for the Japan-China route due to strained Sino-Japanese relationships led to lower business volume at TFK. Nevertheless, the latter remained profitable during the quarter. Going forward, the JPY is likely to remain weak y-o-y. While the diversion of Qantas’ European flights from Singapore to Dubai continued to pressure 2Q14 revenue, management does not expect further negative impact on a q-o-q basis moving forward.

Aviation business likely to be challenging. Passenger traffic at Changi is expected to record moderate growth, while airfreight demand will likely remain weak. The silver lining is the addition of new flight destinations by airlines while the growth in the low-cost carrier (LCC) segment could boost business volume. Higher staff costs will continue to weigh on margins, given a rise in foreign worker levies. Meanwhile, its acquisition of Singapore Cruise Centre is on track. Once completed, it would boost revenue growth and reduce SATS’ reliance on the aviation industry.

Lower estimates; TP unchanged. With JPY expected to remain weak going forward, we lower our assumptions on TFK’s revenue contribution. Hence, we arrive at a slightly lower PATAMI estimate of SGD215m (previously SGD222m) and keep our DCF-based TP of SGD3.49, pegged to a P/E of 18x FY14F earnings. SATS’ share price has risen 9% over the past one month following its acquisition announcement, thus leaving little upside to our TP. Downgrade to NEUTRAL.

Same story as 1QFY14

• Fewer meals served affect results
  
• 2HFY14 to show revenue decline
  
• Counter fairly valued at this juncture
  

2QFY14 results fall short

SATS’s 2QFY14 results were similar to the previous quarter. Revenue came in below our expectations (-2.0% YoY to S$452.1m) following declines in the food solutions segment, and EBITDA fell 11.6% YoY to S$65.7m as a result of higher staff costs. Fortunately, a better performance from its Indian and Indonesian associates managed to offset a weaker contribution from TFK and helped to arrest its PATMI decline to only 3.2% YoY to S$48.7m. Management declared an interim dividend of 5 S cents, similar to last year’s amount.

Weaker 2HFY14 outlook

Qantas’ relocation to Dubai was the main factor for SATS’s revenue decline in 1HFY14. As SATS experiences the full impact on a YoY basis, we are likely to see revenue fall further for 2HFY14. In addition, EBITDA margins (1QFY14: -0.3ppt oya to 13.9%; 2QFY14: -1.6ppt oya to 14.5%) have also fallen due to higher staff costs (wage increments from 1QFY14) and an increase in services to LCCs vis-à-vis premium carriers. This trend is likely to extend into 2HFY14.

Rising staff costs a longer-term concern

An area of longer-term concern is staff costs. With foreigners accounting for one in three workers, SATS qualifies under the Tier 3 dependency ceiling i.e. incurs the highest tier in foreign worker levies and faces further levy increases in Jul 2014/15. Although SATS has the ability to subsidise a portion of that increase due to cost escalation clauses, margins will still be depressed if foreign worker dependency is not reduced. To management’s credit, SATS has embarked on automation initiatives and we await further clarity on cost savings.

Counter fairly valued; maintain HOLD

Due to the weakened 2HFY14 outlook, we leave our fair value estimate unchanged at S$3.35 and maintain our HOLD rating. We foresee limited upside at this juncture and on-going tapering expectations may have a negative impact on dividend-yielding counters such as SATS.

Look Beyond The Near Term Headwinds

Weak set of numbers. SATS reported a fairly weak set of results with net income of SGD48.7m (-3.2% YoY, +5.4% QoQ). Revenue declined by 2%, largely due to lower contribution from TFK Corp. The core business continued to suffer from the impact of rising labour cost in Singapore. The saving grace was a 14% improvement in contribution from its associates in India and Indonesia. We trim our FY03/14-16 estimates by less than 2% to account for the lower-than-expected contribution from TFK Corp. and tweak our DCF-based TP to SGD4.00.

Lower inflight catering volume as expected. 2QFY03/14 unit meals produced in Singapore declined by 4.2% YoY as the inflight catering business was affected by the shifting of Qantas’ long-haul hub from Singapore to Dubai. While negative, this is already in our forecasts and is a well-cited fact.

Look beyond near-term headwinds at TFK. Meals volume in Japan was also lower (-4.5% YoY) due to continued tension between Japan and China. This coupled with the translational impact of weaker JPY against the SGD (-19% YoY) led to lower contribution by TFK. While facing near-term headwinds, the unit remained profitable and we expect growing contributions in the long term. The Japanese government aims to triple visitor arrivals to 30m by 2030 (2012: 8.4m) and we expect the aviation industry to be a natural beneficiary. Furthermore, Japan’s successful bid to host the Olympic Games in 2020 will provide a medium-term kicker.

Maintain BUY, TP: SGD4.00. We maintain our BUY rating on SATS as it is well positioned to benefit from Changi Airport’s ongoing expansion for growth. Furthermore, we believe investors should look beyond current poor performance. With the highly cash generative nature of its business, we see room for higher payout as it optimises its capital structure. The acquisition of Singapore Cruise Centre (SCC) will strategically position SATS as a direct proxy to the tourism growth story in Singapore.

Weaker Japan Operations Weigh On Revenue

SATS posted a 1QFY14 revenue of SGD434.5m (-0.8% y-o-y) on weaker contribution from its TFK subsidiary and a PATMI of SGD46.2m (+11.9% y-o-y). Excluding the writeback for prior year tax provisions and an impairment loss during 1QFY14, PATMI would have risen by 6.8% y-o-y. As passenger traffic growth moderates, Management remains focused on managing costs and raising productivity. Maintain NEUTRAL.

Revenue slightly below expectations. SATS’ 1QFY14 revenue was slightly below our expectations, although PATMI was in line – due to the SGD3.8m writeback of the prior year’s tax provisions and a SGD1.7m oneoff impairment loss. The decline in the JPY, as well as a lower load factor for the Japan-China route, had led to lower business volume for its TFK Corporation subsidiary. Despite that, TFK remained profitable during the quarter under review. Meanwhile, the diversion of Qantas’ European flights to Dubai had an impact on SATS’ overall meal volume.

Outlook stable, but expect challenges. The addition of new flight destinations by airlines, an increase in airline budget for in-flight services offerings and the growth in the low cost carrier segment could help boost SATS’ revenue. However, with the global economy still uncertain, passenger traffic numbers are expected to slow down somewhat. We expect this factor, coupled with the ongoing downtrend for airfreight, to translate into a challenging outlook for the aviation business. The weaker JPY and TFK’s lower business volumes may persist over the next few quarters, although SATS has maintained its positive long-term view on its investment in Japan.

Lower earnings estimate, TP unchanged. We have adjusted our revenue estimate in anticipation of lower revenue growth. We have also tweaked our staff cost assumptions, as SATS has raised some wages. This has prompted us to revise our FY14F PATMI estimates downwards to SGD215.6m. Maintain NEUTRAL.