SGX Yield Stock

Gearing towards an optimal capital structure

•Revenue increased by 12.4% to S$1.7bn, PATMI increased 5.6% to S$191mn.

•Marginal loss at TFK despite low volume and disruptions

•Move towards optimal capital structure to reduce cost of capital

•Adjusted earnings estimates by +1.6%/-1.7% for FY12/FY13E; introduce FY14E

•Maintain Buy recommendation with revised target price of S$3.41.

FY11 within our expectations. SATS’s PATMI for FY11 was in line with our expectations to record a 5.6%y-y increase to S$191.4mn. SATS also consolidated the results of TFK Corp for the first time in 4QFY11 (Revenue: S$72.6mn; Operating loss: S$1.6mn). TFK’s losses for the quarter are fairly small, in our opinion, considering the disruptions to air traffic experienced in the month of March. Despite the translational effects of a weaker GBP against SGD, the UK business managed to record a marginal growth in revenue contribution, which we estimated to be an 8%y-y growth in local currency terms. The core Airport Services business for SATS continues to grow in tandem with the higher traffic at Changi Airport. However, despite the double digit growth in sales, operating profits were flat y-y, due to the changing cost profile for the company.

FY10 FY11 y-y (%) Remarks

Inflation outlook looks manageable, for now

Previously, we had discussed extensively on the effects of food price inflation on SATS. For now, the operating cost profile for 4Q seems to indicate that the cost pressures on raw material cost is manageable. Raw material cost continues to make up c.40% of Food Solutions Revenue and had declined sequentially. However, this figure is slightly distorted by the contributions of TFK in 4QFY11 and we will continue to monitor for SATS’s ability to pass on the higher cost to their customers.

Inflight catering seems to be able to pass on the higher cost?

Recall that some of SATS’s inflight catering contracts with airlines have an embedded inflation peg to its price. Our ASP estimates suggest that SATS was able to raise their unit price to combat the rising food costs. The ASP for their inflight catering business in Singapore trended upwards to S$21/unit meal in 4QFY11. We see this as a sign of the inflation peg taking effect or a better product mix (higher value meals) in the quarter. Either way, it seems to indicate that SATS is able to lift their prices to offset the inflationary pressures.

TFK is not likely to contribute in the near term

TFK’s financial statements were consolidated into SATS’s results for the first time in 4QFY11. Management disclosed that TFK recorded revenue of S$72.6mn and operating loss of S$1.6mn. We translated this value to arrive at an estimate of ¥4.68bn, which is 21% of the revenue attained in FY10. TFK is currently operating at 50% capacity and we believe that the key to TFK being earnings accretive would be to increase its sales volume. However, following the Earthquake on 11th Mar, air travel to Japan had been adversely affected. For example, SIA had disclosed that traffic to Japan declined by c.30%, as compared to pre-crisis levels. We believe that the near term outlook for TFK is negative with poor passenger confidence in air travel to Japan. Hence, we expect TFK to report at least another two quarters of operating losses, before they can be earnings accretive to SATS.

SG Aviation growth continues in 4QFY11

SATS’s operating statistics showed that the Aviation business in Singapore continued its path of growth in 4QFY11. We opine that SATS’s aviation business in Singapore has the best competitive position amongst the various segments. With its dominant position and stable business, the segment is able to generate strong free cashflows to finance its acquisitions and return cash to shareholders.

Towards an optimal capital structure

SATS surprised us by proposing significantly higher dividend payout for FY11 (Special + Final: 12¢). It was surprising as we had expected management to be more conservative in their gearing, as the company recently raised >S$120mn of debt to finance the acquisition of TFK Corp. SATS is likely to tap the debt market to finance any further acquisitions and would gear up towards a slightly more leveraged capital structure. In our opinion, this would significantly reduce the company’s cost of capital and should not have an impact on the interest coverage with strong cashflows contributions from the stable business in Singapore. In view of the likely change in capital structure, we estimate SATS to have a long term WACC of 7.6%.

Valuation

We used a DCF model (WACC: 7.6%; terminal g: 1%) to arrive at our target price of S$3.41. Our target price implies a FY12E P/E of 19X, which is at the top end of its historical P/E range. With significant changes in capital structure and varied risk profile following the acquisitions in recent years, we believe that the historical valuation range could no longer be a good guide for SATS’s future valuation. After including forecasted dividends of 17.3¢ over the next 12months, we expect total return of 34.8%. Hence we keep our Buy call on SATS.

No surprises, cost pressures remain

At a Glance

• 4Q/FY11 results within expectations

• 6 Scts final and 6 Scts special dividends proposed

• Trimmed FY12/13F by 5.6%/1.4% on further increases in cost inflation and TFK operations, offset partially by higher JV/Associates contribution

• Maintain Hold, TP adjusted marginally to S$2.91

Comment on Results

4Q/FY11 within expectations. SATS’ 4Q net profit came in at S$50.5m, capping FY11 at S$191.4m (+5.6%), which were within consensus and our expectations. 4Q topline at S$504.9m (+29%) was helped by S$72.6m revenue contribution from recently acquired TFK Corporation (TFK) and organic growth (S$432.2m, +10.7%). EBIT margins fell marginally by 0.3ppt to 10% as staff costs (S$193.7m, +35%) and raw material costs (S$143.9m, +41%) rose by a faster clip on consolidation of TFK’s operations, absence of Jobs Credit and cost inflation. Net profit was helped by strong contribution from its JVs/Associates (S$15.3m, +18%) arising mainly from maiden consolidation from its Air India-SATS JV.

Final/ Special dividend of 6 Scts each, full year at 17 Scts. Management has proposed a final and special dividend of 6 Scts each, bringing full year DPS to 17Scts (interim DPS: 5 Scts) versus FY10’s 13 Scts (5 cts interim, 8 Scts final). This equates to a payout of 98%. With the special DPS payout, management has indicated its desire to improve its capital structure, and return excess cash to shareholders. Even with the payout, the Group is still in a net cash position.

Recommendation

Cost pressures remain; FY12F/13F trimmed by 5.6%/ 1.4%. We expect to see cost pressures continue, especially from higher labour (FY12F: 38.9% of revenue) and raw material costs (28.2%). While management maintained that TFK would not have a material impact on the Group’s performance in FY12F, we expect overall growth to be affected at least partially, especially with the uncertainty over the time period for travel to revert to normalcy post Japan’s quake/ nuclear situation. As such, we have trimmed our earnings marginally by 5.6%/ 1.4% for FY12F/ 13F.

Maintain Hold, TP: S$2.91. We maintain our Hold recommendation with a revised TP of S$2.91, based on the average of PE (14x FY12F) and DCF (WACC: 7.7%, t=1%). We believe its reasonable dividend yield of c.5% should support share price.

SATS Q4 net profit rises 9% to $50.7m

Operating revenue jumps 29.3%; final dividend payout of 12 cents per share proposed

SATS Ltd announced strong operating numbers all round and unveiled a generous final dividend payout of 12 cents per share yesterday.

The January-March quarter saw attributable profits rise 9 per cent to $50.7 million, from $46.5 million a year earlier. Operating revenue for the quarter increased 29.3 per cent to $504.9 million on the back of higher level of activities and the consolidation of Japan-based TFK Corporation (TFK). TFK contributed revenue of $72.6 million.

However, the ground services operator, which counts Japan Airlines as its main customer accounting for 60 per cent of its revenue, took a hit from the March earthquake and tsunami.

For the full year to end-March, SATS’ attributable profit rose 5.6 per cent to $191.4 million, from $181.2 million. Excluding jobs credit of $17.1 million received in the preceding year and the $6 million in M&A expenses, the underlying profit would have increased 20.3 per cent to $197.4 million.

Revenue rose 12.4 per cent to $1.73 billion, from $1.54 billion. The figure could have been higher if not for some exchange rate translation impact.

For example, SATS’ topline would have been $37 million higher if not for a 9 per cent decline in the value of the UK pound versus the Sing dollar.

Associates and joint ventures contributed some $61.2 million for the year, a 46.1 per cent increase from the $41.9 million a year earlier. Gross dividends from associates/joint ventures peaked at $39.5 million for the year, up 58 per cent from the previous year.

The company is paying a total dividend of 12 cents per share, comprising final dividend of 6 cents plus a special dividend of another 6 cents. Together with interim dividend of 5 cents already paid, total dividend for the year is 17 cents per share. This raised the total payout ratio to 98 per cent.

One of the key challenges the company faced, especially during the final quarter, was material cost inflation, though CEO Clement Woon said the company managed to mitigate the full impact of this via a savvy purchasing strategy.

Cost of raw materials surged 41.1 per cent to $143.9 million during the January-March 2011 quarter. Staff costs rose 35.1 per cent to $193.7 million, mainly due to the absence of job credits.

Operating expenditure for the quarter rose 29.8 per cent to $454.7 million, which was higher than the quarterly revenue of $390.6 million SATS chalked up during the January-March 2010 period.

For the full year the rise was 14 per cent to $1.54 billion – a figure equal to the previous full year’s revenue.

Operating margin for the final quarter shrank to 9.9 per cent, from 10.3 per cent, largely due to the absence of the ‘job credits’ effect. For the full year, operating margin narrowed to 10.7 per cent, compared to 12 per cent in FY2009/10.

The company had cash of some $296.1 million at end-March, compared to $195.8 million a year earlier. Its debt/equity ratio rose to 0.12 from 0.02 a year earlier.

Aviation continued to be its biggest business, contributing to 59.2 per cent of revenue. Food solutions accounted for 46.1 per cent of revenue, while gateway solutions was 31.8 per cent, and its UK foods business accounted for 21.5 per cent. Singapore accounted for over 60 per cent of its topline.

Flights handled rose 7.7 per cent during the year, while passengers handled rose 7.2 per cent. The company saw a significant increase in catering demand for the premium ‘front cabins’, which portends better margins and yields.

Going forward, SATS said it will focus on strengthening its Japan operations by leveraging on the combined competencies within its aviation network.

While it maintained that TFK will not have a material effect on its performance in FY2011-12, it added it would remain vigilant over the ’emerging situation in Japan’ and take appropriate actions should the situation deteriorate.

‘TFK and recent joint ventures, AISATS and Adel Abuljadayel Flight Catering (AAFC) in Saudi Arabia underscore SATS’ continuous efforts to strengthen its international network to serve key airline customers in more locations,’ the company said.

AISATS and AAFC are also expected to be earnings accretive in FY2011-12.

In Singapore, SATS said it would mitigate general cost inflation with more productivity enhancement projects.