• SATS 3QFY19 earnings driven by associates. 
• Long term growth drivers remain intact. 
• Stock supported by 4% dividend yield. 
• Maintain BUY, Target Price S$5.59. 

Maintain BUY, Target Price S$5.59

• We maintain our positive stance on SATS LTD. (SGX:S58) with a BUY recommendation and Target Price of S$5.59. Evidently, Changi’s robust throughput numbers have translated into solid revenue growth numbers for SATS in 3QFY19. We remain positive that Changi and the region’s aviation growth will continue to drive long term earnings growth for the stock.
• The stock continues to be supported by decent dividend yield of 4%.
• Long term growth drivers include
  1. passenger and air traffic growth at Changi Terminal 4;
  2. automation and staff productivity driving modest cost increases and better margins in the next few years;
  3. the opening of Terminal 5 by 2030; and
  4. more positive outlook from TFK Japan.

Where We Differ

• We maintain a positive stance over SATS’ long-term prospects for passenger throughput growth over the next few years with Changi’s development, and Japan’s target of 40m and 60m tourists by 2020 and 2030 which is positive for TFK Japan’s outlook.

Potential Catalyst

• Catalysts for the stock include
  1. better outlook in Japan;
  2. freeing up of financial resources from the Turkish Airlines MOU to pursue other deals and to pay out more dividends; and
  3. faster than expected ramp up of Terminal 4.

Valuation

Blended DCF and PE valuation methodology.

• Our Target Price is S$ 5.59, which is based on the average of discounted cash flow (DCF) valuation (7.6% weighted average cost of capital and 3% terminal growth assumption) and PE valuation pegged to 22x FY20F earnings (from FY19F previously).

Key Risks to Our View

• Our earnings growth takes into account a recovering aviation outlook and better cost structure. Slower recovery in air traffic and failure to keep operating costs in check are key risks to our arnings and Target Price.

What's New - 3Q19 Results

3Q19 earnings in line:

• Headline 3Q19 earnings of S$68.9m (+3.5% y-o-y) was within estimates. However, the quarter’s earnings included a S$5.8m one-off benefit from associate income stemming from the disposal of DFASS SATS Pte Ltd to KrisShop Pte Ltd. Excluding this one-off, profit before tax would have been S$80.6m, flat from 3Q18 on a comparable basis. Otherwise, core operating profit was largely flat at S$65.3m (-0.6% y-o-y).

Revenue driven by Gateway Services and non-Aviation Food:

• Revenue grew by 5.5% y-o-y to S$464m, driven by Singapore aviation segment, particularly Gateway services. Gateway services’ revenue grew by 6.3% y-o-y to S$211.3m backed by more passenger and cargo volumes at Changi, and supported by increased ship calls and passenger volumes at Marina Bay Cruise Centre.
• Food solutions grew by 5% y-o-y to S$252.4m on higher volumes. TFK meanwhile was higher by 1.8% y-o-y to S$61.6m led by aviation growth in Japan.

Higher overall opex, lower operating margins.

• Opex was 6.6% y-o-y higher at S$398.7m driven by increases across the board especially higher staff, raw materials, premise, utilities expense and other costs (which includes professional fees, productivity projects and new kitchens). Some of these costs were one-off.
• Staff costs was 5.1% y-o-y higher at S$10.6m while raw materials was 7.8% higher at S$5m Operating margin declined marginally by 0.8ppt to 14.1% as a result.

Associates income growth led by gateway and helped by one-off gains:

• Associates and JV income came in at S$20.7m which included a S$5.8m one-off gain from the disposal of DFASS SATS Pte Ltd to KrisShop Pte Ltd. Income would have been S$14.9m, or 8.8% y-o-y higher backed by strong core gateway associates contribution (S$12m, +13.2% y-o-y) except for the Indonesian associates.
• Food solutions associates were lower at S$2.9m (-6.5% y-o-y) led by Brahim’s lower volumes and Evergreen Sky Catering’s depreciation from a new kitchen.

Continues to track our growth estimates.

• Overall earnings continue to track our estimates on the back of stronger than expected revenue. Although core operating profit was slightly below, there were some one-off operating expenses which we expect will not recur in the coming quarters. Associates revenue should also see improvement going forward as we anticipate the price hike at the Indonesian associates to kick-in going forward.
• Evidently, Changi’s robust throughput numbers have translated into solid revenue growth numbers. The long-term drivers of Changi’s growth continue to remain intact and we remain positive that Changi and the region’s aviation growth will continue to drive long term earnings growth for the stock. Stock continues to be supported by decent dividend yield of 4%.

Maintain BUY, Target Price S$5.59

• Our earnings estimates are largely unchanged. Growth going forward will stem from
  1. passenger and air traffic growth at Changi Terminal 4;
  2. automation and staff productivity driving modest cost increase and better margins in the next few years; and
  3. the opening of Terminal 5.
• Our Target Price is derived from a blended valuation using 22x FY20F EPS and DCF (7.6% weighted average cost of capital and 3% terminal growth assumption).
• Stock is supported by FY20F dividend yield of 4.0%. Maintain y for 12% capital upside.

Source: DBS Research - 14 Feb 2019