Investments and Capex to Materially Ramp-up. BUY

• The key takeaway from SATS LTD. (SGX:S58)’ recently held Capital Markets Day was the guidance of spending to rise to 2.5x the level witnessed in recent years.
• While positive for medium term growth, profits will be weighed for a couple of years with upfront costs during the gestation period characteristic in new investments. Hence we cut our FY20E/21E PATMI by 13-15% but our DCF based Target Price has increased 5% to SGD6.10 factoring medium term contributions and a more efficient balance sheet.

CSGD1b Spending Earmarked for FY20-22E

• SATS indicated that proposed capex and investment over the next three years was planned at around SGD1b. This implied SGD333m average per year is 2.5x the SGD136m average of the past five years.
• The objectives are to:
  1. increase presence in the APAC aviation catering and air cargo market;
  2. become a leading central kitchen supplier in specific APAC markets; and
  3. develop a presence travel retail.
• Management believe that Asian aviation catering market is poised for consolidation driven by airline-affiliated caterer divestments and a growing pool of long shelf-life food producers driven by food technology development.

Central Kitchens An Emerging Growth Driver

• Management are excited about the growth prospects of the relatively new central kitchen business in China.
• Recall the company announced its first non-aviation central kitchen development in Kunshan with the Wilmar Group (WIL SP; SGD3.36; NR) in early 2017; this development subsequently achieved operating breakeven a few quarters ahead of plan spurred by the strong demand from food service chains for large batch requirements with consistency, quality and safety.
• SATS is planning to expand its total production capacity in the Beijing-Tianjin-Hebei area from 70K meals/day to 200K meals/day, while its kitchens in the Yangtze River Delta currently have a capacity of 120K meals/day.

Japan Has Stabilised; Now Gearing for Growth?

• As we mentioned in earlier results notes, SATS TFK revenues started stabilising late-2017 and has been growing at low-to-mid single digits since. Indication from management of some possible capacity addition suggests that the prior oversupply situation at Haneda and Narita airports is on the mend.
• We expect TFK’s performance should improve further from traffic growth leading to the 2020 Tokyo Summer Olympics.

Forecast Changes

• We have cut our FY19E-FY20E core profit forecasts by 13-15%. While there are a number of adjustments we have made, the lion’s share of the decline in forecasts is principally from factoring in the higher upfront costs and capex in line with the more aggressive expansion plans that the company plans to pursue over the next three years.
• Given that some gestation period has been characteristic in many of SATS’ prior ventures and investments, we have similarly assumed a lag of 18-24 months ramp-up before seeing any positive contributions at the operating level.
• There is no specific detail on upcoming investments at this point, and as a result our forecast adjustments have been made on the basis of the following broad assumptions:

Upfront Expansion Costs

Expansion cash opex expensed:

• We have raised staff, facilities and other costs by an incremental 1-2ppts growth for the two year period as we have similarly seen increases in these areas during periods of higher investment intensity from the company.

Spending plan:

• Amount: We have assumed the SGD1b capex and investment plan is evenly spread out over the three year period for FY20E-FY22E (i.e. at SGD330m per year). Our earlier capex and investment forecasts were to the tune of SGD80-100m per year.
• Split: We have also assumed a capex versus investment proportion of 45%:55% for each of the years or specifically SGD150m capex and SGD180m investment per year. Note that a material difference in this assumed split would correspondingly affect the level of depreciation charges (as well as associate earnings).

Other Forecast Changes

Revenue:

• The net impact of the following two adjustments elaborated on below has been a 2-3% uplift to our earlier FY20E-FY21E revenue forecasts. The revision is due to:
  1. raising our assumptions for non-aviation gateway and other revenues, which have been tracking better than expected in recent quarters; and
  2. tweaking down our expectation for aviation food solutions volumes for Singapore due to the slow-down in Chinese visitor arrivals in recent months.

Associate/JV profits:

• We have lowered estimates 8-15% for FY20E-21E as we impute a longer recovery from Brahims Catering in Malaysia and also an additional 3-4 quarters in the timeframe that we expect for the 2018 increase in concession fees in Indonesia to be priced through to customers.

What to Look Out for in FY20E

• New investments related to the increased capital spending plan aside, here are some of the key areas from which we expect to hear news and developmental updates during the current financial year:
  • We expect existing operations in Singapore to benefit China in Lungfang is currently being constructed. We expect it to potentially start operations during the current financial year.
  • Operational updates on recent investments ramping up: the greenfield cargo facilities developed in Dammam in the Kingdom of Saudi Arabia and the 49% JV concession to manage a cargo facility at Mumbai’s International Airport.
  • Deal closing and updates on its recently announced investment in May- 2019 for 50% of Nanjing Weizhou Airline Food Company, an entity with expertise in frozen and ambient meals with distribution channel partners serving 80 domestic airports across China.
  • An update on Brahims SATS Sdn Bhd where SATS has a 49% minority stake, as the entity’s parent, Brahims Holdings Bhd, has slipped into a PN17 status since 1Q19 (PN17 is a notice issued by the Malaysian stock exchange when a company breaches certain financial ratios and is considered to be in financial distress).

Valuation and Risks

• Our discounted cashflow based Target Price has been raised by 5% to SGD6.10 from SGD5.80. There are two factors driving this increase:
  • Contribution from new term. While FY20E-21E profits have pedestrian 2-3% forecast earlier.
  • Lower weighted average cost-of-capital (WACC). The higher levels averaging around SGD250-300m over this period. We expect long term average net gearing to range between 20-30% going forward and have assumed a long term net gearing level of 20% for our DCF assumptions (vs. zero earlier). This translates to a 90bps reduction in our WACC estimate for SATS from 7.7% to 6.8%.

Source: Maybank Kim Eng Research - 12 Jun 2019