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.

1QFY14 profit in line despite lower revenues

• 1QFY14 net profit was boosted by a tax write-back
  
• Revenues slipped due to lower contributions from TFK and Qantas Airways
  
• EBIT margins improved marginally on the back of lower operating costs
  
• Maintain HOLD, TP is intact at S$3.29
  

Highlights

1QFY14 profit in line. Net profit grew 11.9% to S$46.2m while revenues dipped 0.8% to S$434.5m. There was a S$3.8m tax writeback in the quarter and it booked S$1.7m impairment charge on assets held for sale. Excluding these items, net profit would have registered lower 6.8% y-o-y growth to S$44.1m.

Lower revenues due to TFK, lower meals uplift. 1QFY14 revenues were affected by lower contribution from food solutions (-5.6%), partly offset by higher gateway contribution (+7.9%). The weaker food solutions contribution was due to a 22% drop in TFK’s revenues as a result of a weaker yen and lower load factor amid strained Sino-Japan relations. Food solutions revenue was also affected by a 6.6% dip in unit meals uplifted, largely a result of Qantas moving its European flights to Dubai, from Singapore. Qantas redrawn about 52 flights/ week, which accounts for about 2% of total flights handled by SATS.

EBIT margins improve marginally to 9.4%. The dip in revenue was mitigated by lower operating expenses (-1.2%). The drop in opex was led by lower raw material costs (-2.8%), depreciation (-14.7%), premise and utilities expenses (-7.6%), and others (-2.5%).

Our View

Limited re-rating due to weak outlook. 1QFY14 earnings were in line at c.22% of our FY14F profit, similar to the year-ago quarter. There is little scope for share price upside in view of moderating passenger traffic growth and declining airfreight volume. However, this should be mitigated by its commitment to manage costs, as well as relatively attractive yields.

Recommendation

Maintain HOLD, TP S$3.29. SATS is currently trading at +1 SD of its historical PE band, in line with regional/global peers’ average. Our TP is the average of the values derived from our DCF model (WACC 7.7%, t=1.5%) and PE valuation model (16x FY14/15 EPS).

If Dividends Be The Food Of Investors, Then Pay On!

Structurally higher dividends. We see a multi-year re-rating of SATS as we believe that the company is likely to structurally increase their dividend distribution to shareholders. SATS announced special dividends in the last 3 years and we expect this to be the new normal. Management had previously highlighted their desire to optimize their capital structure (long run target: net debt to equity of 0.3X), which we view as a signal for structurally higher dividend distributions to shareholders.

Sufficient funding for M&A. Even after factoring in progressive increments in dividends over the next 3 years, we forecast a net cash position of more than SGD400mn by the end of FY16E. This implies that SATS would have a sizeable war chest of c.SGD900mn, should they achieve a capital structure with net debt to equity of 0.3X by the end of FY16E.

TFK Corp on the rebound. SATS offers an exposure to the aviation market in Japan through its inflight catering arm, TFK. The latest results from SATS suggest that TFK had turned a corner with FY13 EBIT contribution of SGD12.1mn (FY12: SGD0.3mn). While the weaker JPY would lead to lower contributions upon translation to SGD, we believe that the positive economic impact of a weaker JPY (eg. tourism, business travel) should result in a net positive effect on air travel demand and TFK. Either way, we expect TFK to continue leveraging on SATS’s existing business relationships with various airlines to clinch more contracts.

Our forecasts are above consensus. We are 8% above street view for our FY14-16E estimates, as we believe that consensus numbers may not have factored in incremental contributions from new contracts and our expectations of margin expansion as they scale up their operations.

Valuation. We believe that a DCF (WACC: 8.0%, terminal g: 1.0%) based valuation would best reflect the strong cash-generative nature of the company. Upgrade to BUY with TP of SGD3.90/shr.

If Dividends Be The Food Of Investors, Then Pay On!

Structurally higher dividends. We see a multi-year re-rating of SATS as we believe that the company is likely to structurally increase their dividend distribution to shareholders. SATS announced special dividends in the last 3 years and we expect this to be the new normal. Management had previously highlighted their desire to optimize their capital structure (long run target: net debt to equity of 0.3X), which we view as a signal for structurally higher dividend distributions to shareholders.

Sufficient funding for M&A. Even after factoring in progressive increments in dividends over the next 3 years, we forecast a net cash position of more than SGD400mn by the end of FY16E. This implies that SATS would have a sizeable war chest of c.SGD900mn, should they achieve a capital structure with net debt to equity of 0.3X by the end of FY16E.

TFK Corp on the rebound. SATS offers an exposure to the aviation market in Japan through its inflight catering arm, TFK. The latest results from SATS suggest that TFK had turned a corner with FY13 EBIT contribution of SGD12.1mn (FY12: SGD0.3mn). While the weaker JPY would lead to lower contributions upon translation to SGD, we believe that the positive economic impact of a weaker JPY (eg. tourism, business travel) should result in a net positive effect on air travel demand and TFK. Either way, we expect TFK to continue leveraging on SATS’s existing business relationships with various airlines to clinch more contracts.

Our forecasts are above consensus. We are 8% above street view for our FY14-16E estimates, as we believe that consensus numbers may not have factored in incremental contributions from new contracts and our expectations of margin expansion as they scale up their operations.

Valuation. We believe that a DCF (WACC: 8.0%, terminal g: 1.0%) based valuation would best reflect the strong cash-generative nature of the company. Upgrade to BUY with TP of SGD3.90/shr.

Cruise control

SATS wrapped up FY13 on a pleasant note, not only reporting stronger-than-expected profits but also dishing out higher-than-expected dividends.

FY13 core net profit surpassed Street and our expectations by 8% on the back of margin strength. We fine-tune our FY14-15 EPS by less than 1% and raise our target price (still at 16.8x CY14 P/E, 1SD above its 8-year mean) marginally. Maintain Outperform with re-rating catalysts to come from growth in Changi Airport’s passenger traffic.

Leveraging Changi Airport’s growth

We expect strong intra-Asia travel to buoy SATS’s revenue. Stronger passenger volume had lifted its FY13 revenue by 8% yoy, with revenue growth across the board: gateway services (+8%) and food solutions (+8%). High staff costs were mitigated by slower rises in raw-material costs, supporting a 0.6%-pt expansion in EBIT margins to 10.6%. Excluding a S$16.8m impairment charge relating to its divestment of Daniels, core net profit grew 20%.

Gateway services hit by labour costs

Costlier labour took a toll on gateway services EBIT (-54%). Wage inflation was attributed to headcount increases and foreign-worker levies. Fortunately, growth from food solutions overwhelmed the weakness. EBIT margins from food solutions gained 2.8% pts, thanks to slower rises in raw-material costs and productivity gains.

Dividend sweetener

A 6ct final dividend and 4ct special dividend was declared, taking FY13 DPS to 15cts, above our 11.8ct forecast. Dividend prospects remain favourable with SATS enjoying positive free cash flows and a net-cash position.