• We have cut SATS (SGX:S58)'s FY20-21F earnings by 2-12% as we impute lower revenue and margin outlook as well as lower contribution from associates and JVs as a result of the COVID-19 outbreak. Growth is now expected to decline marginally in FY21F.
• Downside is supported by dividend yield of 4.4%.
• Maintain HOLD  with Target Price SGD4.46 until the virus situation and regional travel outlook improves.

SATS' 3Q20 Results Below Expectations

3Q20 earnings below on higher opex:

• SATS's 3Q20 earnings of S$59.3m (-14% y-o-y) was below our forecasts. While revenue beat our expectations, EBIT and profit before tax were 5% below our estimates, led mainly by higher raw material and other miscellaneous operating expenses.
• Revenue of S$545.6m (+17.6% y-o-y) was driven by both Gateway (S$234.3m, +11% y-o-y) and Food Solutions (S$310.3m, +23% y-o-y). Associates/JV income was in line at S$14.7m.

Core revenue flat:

• Contribution of three key entities that were absent last year aided revenue growth. Stripping out their contribution, core revenue would have been flat at S$464.9m with growth in Japan offset by decline in non-aviation food in China.
• Core Gateway revenue declined on lower cargo volume and ship calls. Core Food Solutions revenue was flat with non-aviation food’s declining due to the absence of Food and Allied Support Services Corporation’s (FASSCO) revenue as it was divested in July 2019, offset by better revenue performance in Japan on the extension of its kitchen and addition of new slots in Haneda.

Revenue growth boosted by consolidation impact:

• Gateway revenue was helped by consolidation of Ground Team Red which was absent last year (consolidated since January 2019) adding S$23.5m to the S$23m increase in revenue, as core Gateway revenue declined due to cargo.
• Food Solutions saw the consolidation of Country Foods (formerly SATS BRF since September 2019) and Naning Weizhou Airline Food Corp (since October 2019) that were absent last year adding S$42.3m and S$14.9m to the S$58.4m increase in Food Solutions revenue.

Higher operating expenses, lower margins:

• EBIT came in 5% below our expectations at S$62.9m (-3.7% y-o-y) as operating expenses rose 21.1% to S$483m. Raw material costs rose 35% y-o-y to S$110.4m with the consolidation of Country Foods.
• Operating margins consequently dropped to 11.5% (-2.6 ppts) largely on the lower cargo volume and the consolidation of Country Foods.
• Cargo handled for 9MFY20 was down 1.6% y-o-y to 1,397,000 tonnes.

Outlook Marred by Headwinds on Regional Aviation

COVID-19 to cause travel reduction.

• We see reduction in regional travel as a result of COVID-19, eventually affecting regional aviation and SATS’s earnings outlook. Lockdown of Wuhan, travel restrictions in Singapore and temporary suspension of Macau gaming operations in addition to the reduction of unnecessary travel regionally, would lead to lower regional tourist movements.

Closure of Macau casinos for 15 days will affect tourist arrivals and spending:

• Macau has asked its casino operators to suspend operations for two weeks as a measure to curb the spread of COVID-19. The gaming sector, including gaming operations and hotels, is undergoing a 15-day closure from midnight 5 February and resuming on 20 February.

Singapore has implemented travel restrictions.

• Travel restrictions have also been implemented in Singapore, banning all mainland Chinese passport holders and all foreigners who have been to China within the past 14 days from entering or transiting through Singapore from 2559 hours since Saturday, 1 February till further notice.

Key Impact on SATS Would be From Changi Airport

Singapore accounts for majority of SATS’s revenue.

• SATS’ primarily operation is at Singapore’s Changi Airport with Singapore contributing 82% of FY19 revenue. It has no operations in Wuhan but has network of Gateway and Food Solutions businesses across Shanghai, Beijing Tianjin, Shenyang, Jilin, Hong Kong and Macau. China accounts for less than 4% of revenue.

SATS dominates ground handling at Changi Airport.

• As a leading ground handler with about 80% market share at Changi, SATS has high exposure to Singapore’s tourist arrivals particularly throughput of passengers, flights and cargo through Changi Airport. It has been a beneficiary of growing air traffic at Changi.
• We estimate revenue from derived from Singapore aviation food and gateway services to be about 70% of revenue. We expect ground, ramp, gateway and flight kitchen operations in Singapore to be affected by decline by lower tourist arrivals.

China tourists a key source of arrivals into Changi.

• China tourists make up about 10-11% of arrivals into Changi. Singapore arrivals into Changi Airport was 34.1m passengers in 2019 (works out to passenger movement of 68.3m at Changi) with 3.7m passengers from China (10.8% of Changi arrivals, +8% y-o-y).
• According to Singapore Tourism Board, China is the largest source of tourists in Singapore followed by Indonesia, India, Malaysia and Australia in 2019.

How much did passenger arrivals decline during SARS in 2003?

• Cut in regional air travel would lead to lower throughput at Changi, which saw passenger arrivals at Changi decline by 50-60% in Apr-May 2003 (-9.5% y-o-y for CY2003). This resulted in 15% y-o-y lower earnings in 2004 and 9.3% y-o-y decline in revenue.

Lower Earnings Expectations

Tourist arrivals could decline by 10% y-o-y in CY2020.

• The Singapore Tourism Board has already reported that visitor arrivals are currently down by about 20,000 a day. Based on last year’s tourist arrivals of 19.1m, this run rate suggests a 38% decline in average daily tourist arrivals.
• Assuming this run rate lasts for three to four months, and tourists arrivals recover back to 4% y-o-y growth for the rest of the year (with the help of promotions), we estimate that tourist arrivals at Changi for CY2020 would decline between 6-10% y-o-y.

Cut FY20-22F earnings by 2-12%.

• We cut FY21F earnings by 12% to factor in the impact of slower Changi throughput. We forecast a revenue decline of 1% y-o-y which removes Changi’s historical passenger growth of 3-4%, as well as taking into account one to two months of weak passenger arrivals from April 2019 (start of FY21F). Our operating margins are lower given that opex including staff costs are largely fixed.
• Along with a slightly lower Associates/JV contribution, we expect earnings to decline marginally in FY21F. The downside risk to our forecast would be a prolonged COVID-19 situation which subdues travel demand.

Remain Neutral on the Stock

• SATS is currently trading at 4.4% FY21F dividend yield at +1 SD of its 7-year dividend yield average of 4.1%. While we see downside to earnings, dividend yield should support the share price, provided there are no DPS cuts.
• SATS has set its dividends based on a DPS that it feels its business’s cashflow can sustain. The stock is also trading near its mean forward PE average of 22.9x.

Source: DBS Research - 14 Feb 2020