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Simons Trading Research

Author: simonsg   |   Latest post: Thu, 17 Oct 2019, 10:26 AM

 

SATS - 4QFY19 Weak JV & Associate Earnings Indicative of Tough Operating Environment

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  • The core 5.4% decline in 4QFY19’s earnings was entirely due to lower earnings from JV and associates. While SATS LTD. (SGX:S58) emphasised that the profit variance for the segment was just S$7.7m, it nonetheless highlights a difficult operating environment as well as margin pressure.
  • We also expect air cargo traffic to decline further in 2019 and this could further pressure SATS’ earnings. We thus downgrade the stock to HOLD.
  • Target price: S$5.05. Suggested entry price: $4.60.

Sats 4qfy19 Results

Core net profit for 4QFY19 declined by 5% yoy to S$248.4m, 4% below our and street forecasts.

  • Excluding S$7m in one-off gains in FY18, SATS LTD. (SGX:S58)'s core net profit for FY19 grew 2.2% y-o-y. A steep 63% decline in associate earnings was the key reason behind the disappointing results. At operating level, SATS managed to register 10.1% y-o-y gain, but excluding the consolidation of associate GTR, operating profit would have risen 6.1% y-o-y.
  • 4QFY19 staff cost rose by S$27.1m (+13% y-o-y) partly due to the consolidation of GTR and also because of a S$6m reduction in employment credit.
  • SATS raised its final dividend payout by 1 S cent to 13 S cents. SATS generated operating cash flow of S$295.7m (+20%yoy) and FCF of S$208.1m (+42% y-o-y) for FY19.

Food solutions JV fell a whopping 86% in 4QFY19, while gateway services JV fell 32% yoy during the same period.

  • Excluding one-off gains in both periods, associate and JV income would have fallen S$7.7m y-o-y. SATS also indicated that it made doubtful debt provision of S$3.3m for the gateway services. SATS had also consolidated its JV with AirAsia at the start of 4QFY19, which would theoretically have lowered gateway services JV income by S$0.8m.

Acquisition 50% of Nanjing Weizhou Food company

  • SATS also announced the 50% acquisition of Nanjing Weizhou Food company (Nanjing Weizhou) for an initial consideration of S$25.5m, with additional S$5.7m subject to the successful completion of the proposed transfer.
  • Nanjing Weizhou has been supplying aviation food for 19 years to 80 domestic airports and is the leading independent aviation food supplier. Nanjing Weizhou has a central kitchen at Jiangsu province, from which it supplies frozen and ambient food to airlines, including the big four Chinese carriers.
  • SATS is optimistic of the long-term growth prospects for the JV. The total acquisition cost of S$31.2m approximates 2.7x Nanjing Weizhou’s book value as at end 2018.

Operating margin for the food solutions segment has deteriorated

  • Operating margin for the food solutions segment has deteriorated for three consecutive years, amid pricing pressure from airlines. As at end-FY19, operating margin for food solutions amounted to 15.4% (-0.4ppt), while ROE amounted to 20.3%, (-1.8ppt).

Stock Impact

Air cargo volume is likely to remain weak in FY20

  • Air cargo volume is likely to remain weak in FY20 and is likely to lead to lower gateway services revenue for SATS and its JVs. We are also perturbed by the continued weakness in associate earnings, even as SATS continues to expand overseas.
  • While group revenue is rising, net margin is clearly deteriorating for JVs and associate. With signs of a global economic slowdown, we are now less confident of growth from associates.
  • SATS had invested S$119m in GTR, but based on 4QFY19’s results, the associate would have generated about S$0.8m in the quarter. On an annualised basis, ROIC appears to be low at under 3%.

Earnings Revision / Risk

  • We lower our FY20 and FY21 net profit estimates by 5.6% and 7% respectively, factoring in lower associate earnings.

Valuation / Recommendation

Downgrade to HOLD with a target price of S$5.05 (S$5.60 previously).

  • We value SATS on EV/Invested Capital basis WACC of 6.1%, long-term ROIC of 14.8% (previously 15.7%) and growth rate at 2.3%. At our fair value, the stock will trade at 22x FY19 PE.

Share Price Catalyst

  • None in the near term.

Source: UOB Kay Hian Research - 21 May 2019

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