• Headline net profit was boosted by a S$5.8m EI gain from associates. Flat underlying earnings were due to high opex, including about $2.0m in non-recurring costs.
• While revenue growth is impressive, SATS faces the challenge of controlling costs to allow for positive jaws. Still, we like SATS for its substantial exposure to fast growing markets and strong balance sheet, which could provide opportunities for M&A.
• Maintain BUY and target price of S$5.60.

3qfy19 Results

Marginally below expectations, but no reason to be concerned.

• Underlying profit (excluding EI gain of S$5.8m at associate level) was flat, vs our expectation of mid-single-digit growth.
• Staff cost rose (+5.1% y-o-y) at a slightly higher rate than expected, partly due to reduced employment credits. There was also a $3.4m increase in other costs as well as slight bump up in depreciation and amortisation (D&A), due to an overseas investment, which had not commenced operations. Excluding the S$3.4m increase in other costs, SATS LTD. (SGX:S58) indicated that there would have been positive jaws for the quarter.
• SATS indicated that a third of the increase in “other costs” were due to professional fees, another third was due to IT related costs and the remainder due to digital supply chain projects. SATS also indicated that only a third of the costs are likely to be recurring.

Impressive top-line growth.

• 3QFY19’s 5.5% revenue growth is the highest for the financial year and was impressive given the economic headwinds, though we believe that growth could taper out particularly for air cargo operations in the coming quarters.
• SATS indicated that higher ships handled at Marina Bay led to significant operating leverage, while the China food solutions business was also a key factor in the non-aviation food solutions growth.

Excluding EI gain of S$5.8m from the transfer of DFASS-SATS to SIA, JVs and associates, up 8.8% y-o-y.

• This in turn was underpinned by a 13% y-o-y rise in gateway services segment, which was a reversal from the past two quarters of declines. The improvement was led by JVs in India, Hong Kong and Malaysia.
• Indonesian JV, PT CASS, did not register earnings growth but management expressed confidence for better contribution in 4QFY19.
• Food solutions JV earnings continued to decline for two consecutive quarters but the pace of decline narrowed from the previous period’s 27.5% decline to a 6.5% decline. SATS indicated that this was due to weak earnings from Brahim. SATS highlighted that its GM has seconded Brahim and hopes that earnings will improve. We are less hopeful as the imposition of a passenger departure levy could hurt volume growth and pricing.
• SATS also reversed an earlier earn-out consideration of S$11.6m from Brahim as targets were not met and it recognised an impairment loss on the latter.

SATS generated a 20% y-o-y rise in operating cash flow for 9MFY18.

• Recurring free cash flow (FCF + dividends from associates) rose 61% to S$158.1m, offering scope for a higher dividend payout for the full year.

Stock Impact

Strong underlying revenue growth and exposure to emerging markets are key reasons to stay invested.

• Greater China, India and ASEAN ex-Singapore account for 24% of group revenue inclusive of associates and these regions have the fastest growth.
• SATS’ challenge would be to improve margins at these regions but management expressed optimism towards China, particularly on its inflight catering operations and for its existing central kitchen at Kunshan and future kitchens at Tianjin, Guangzhou and Beijing.

SATS is optimistic of the long-term prospects at Beijing Daxing Airport, but we do not expect any material contribution in the next two years.

• Beijing Daxing Airport (BDA) is expected to commence operations in Oct 19. We are not optimistic of growth prospects out of BDA for the next two years.
• SATS’ JV partners, China Southern Airlines and China Eastern, would be hub operators at BDA and their transition from Capital Airports over the next 2 years might not lead to a significant increase in flights out of Beijing, based on China’s civil aviation authorities guided transition plan. In addition, SATS’ stake in the food catering JV at BDA will be 10%, compared to 28% at Capital Airports.

Earnings Revision / Risk

• We raise our FY19-20 net profit estimates by 3.5%, factoring in higher associate earnings, including the EI gains from the latter.

Valuation / Recommendation

• Maintain BUY and target price of S$5.60.

Share Price Catalyst

• Investments in new flight kitchens in China.

Source: UOB Kay Hian Research - 14 Feb 2019