• 1QFY15 results below forecasts
• Focus on creating operating leverage
• Maintain HOLD

1QFY15 results below expectations

SATS’s 1QFY15 results came in below our expectations. Revenue increased 0.2% YoY to S$434.5m, or 6.4% below our forecast. Food Solutions revenue dropped by 0.9% to S$262.7m due to weaker performance from subsidiary TFK. The drop is smaller compared to the previous quarter’s 5.7% as the effect of Quantas’ move to Dubai from Changi Airport is absent in the current quarter’s YoY comparison. Gateway Services revenue increased by 2.0% to S$171.2m, which we deem to be largely in line with the 2.5% growth in flights handled in Singapore. Despite top line growth, PATMI dropped 6.3% YoY to S$43.3m, which is 4.6% below our estimate. This is due to: 1) lower operating margin (-0.3ppt to 9.1% in 1QFY15) mainly caused by higher staff costs, and 2) lower contributions from associates and JVs (-16.8% YoY to S$10.4m in 1QFY15) on the back of muted Asian cargo volumes.

Creating operating leverage is multiyear process

Management guided that headcount reduction will continue as processes are made more efficient. Capex spending is rising (S$14.2m in 1QFY15 vs. S$12.8m in 1QFY14) and will stay elevated. Additionally, airlines at existing Changi Airport terminals are still switching to self-check-in processes, eventually reducing the need for staff. With regional airlines struggling, we think the cost-saving switch will come in the foreseeable future. We note that initiatives to create operating leverage are multi-year processes which involve clients as well. Thus, we are not too worried about the current fall in operating margin.

M&A to tap on regional air traffic growth

Management said they are on the lookout for M&A opportunities to grow inorganically. SATS is well-poised to do so with a healthy net cash balance of S$270m and interest coverage ratio of 99x as of Jun-14. This is likely a key source of overseas growth going forward, to enjoy economies of scale in a capital intensive business. Incorporating the latest results and retaining a 20x FY15F PER, we derive a lower TP of S$3.20 (previous: S$3.23). Maintain HOLD.

Source: OCBC Research - 23 Jul 2014