• SATS's 4QFY20 net loss was S$6.3m and core profit was S$5.6m (vs. guided:S$15m-19m) due to impairment losses and extension of government grant.
• No final dividend. SATS's 1QFY21F losses likely to be narrower vs. initially guided S$50m-70m due to non-aviation (community services) and painful cost cuts.
• We think it is still too early to see greenshoots in international travelling patterns, and project losses for the next three quarters. Reiterate REDUCE.

SATS Missed Guidance Due to Impairment Losses and JSS Extension

• On 30 Apr, SATS (SGX:S58) guided for 4QFY20 net profit of S$15m-19m (down 60-70% y-o-y) and FY3/20 net profit of S$186m (-25% y-o-y). It also guided for 1QFY21F loss of S$50m- 70m. In May, the Institute of Singapore Chartered Accountants issued its guidance on the accounting recognition of the Jobs Support Scheme (JSS). SATS extended recognition of the grants over 11 months till Dec, resulting in lower grants being recognised in 4QFY20 and 1QFY21F. SATS recognised S$21.9m or two months of JSS grants in 4QFY20.
• There were also S$51m in asset write-downs, impairment losses and provision of doubtful debts at SATS and its associate levels. This resulted in 4QFY20 net loss of S$6.3m and FY20 net profit of S$168m (-32% y-o-y).
• SATS's 4QFY20 core net profit was S$5.6m.

1Q21F Will be Better With Non-aviation and Cost Cutting

• Non-aviation revenue (mainly food solutions) rose 50% y-o-y to S$100m in 4QFY20 while aviation revenue dropped 18% y-o-y to S$332m and gateway revenue dropped 18% y-o-y to S$S185m.
• Other than India, all of SATS's overseas operations saw losses in 4QFY20. China posted the highest loss (-S$31m), followed by ASEAN (-S$16m), and Japan (- S$2.7m). SATS expects 1QFY21F losses to be lower than its original S$50m-70m guidance due to its cost savings initiatives and new non-aviation revenue via Country Foods, Singapore Food Industries and new government contracts for community services e.g. cooking/housing for foreign workers and protein supply chain management.
• Staff costs dropped 26% y-o-y in 4QFY20 to S$174m (40% of sales vs. 9MFY20 of 47%).

Pax Numbers at 5% or Less, Base Case Is a Full Recovery in 2023F

• In Apr and May, Changi pax movement plunged 99.5% y-o-y to 25,000/month, and flights handled dropped 87% y-o-y to 4,200/month. SATS said the passenger volume is at 5% of capacity or less now. Its Changi catering capacity in ICC1 is being used for non-aviation services; ICC2 is not operating profitably.
• Responses from airlines on the issue of recovery are still mixed; SATS uses International Air Transport Association's (IATA) outlook as its base case i.e. aviation volume will not return to 2019's level until 2023F.

Associates Could Take Longer to be Profitble

• Associates and JVs posted a loss of S$31m in 4QFY20, mainly due to lower business volumes as well as impairments made for credit losses, and asset impairments in view of Covid-19. We estimate about S$27m of such non-recurring losses were recorded in 4QFY20. Management foresees some capital injection ahead.
• We expect losses from associates/JV to persist into 2QFY21F, potentially affected by extended/resurgence of lockdowns. At SATS's level, there was a S$11.9m of impairment loss on investment in assets which we believe is mainly related to China aviation.

How Profitable Is SATS' Non-aviation Business?

• Management is transparent in guiding for a lower margin for non-aviation catering. Overall EBIT margin in 4QFY20 dropped to 9.6% (9MFY20: 12.3%). Food solutions EBIT margin declined to 12.7% in FY20 from 15.4% in FY19. However, management believes this segment is less capital intensive and could fetch better return in investment. Covid-19 has also caused SATS to allocate more resources to this segment which includes community feeding, retail and home delivery.
• Its recently-consolidated subsidiary Country Food has a large proportion of distribution network for processed protein (poultry) into the retail value chain. It has also increased its market share in protein import to diversify Singapore’s food supply chain. In Japan, its catering facilities have expanded into retail sales. SATS's non-aviation growth plans for China remain unaffected by Covid-19.
• Home delivery is also another growing market that SATS is exploring, leveraging its existing aviation catering facilities. This includes supplying ingredients to commercial cloud kitchens.

When to Turn Positive on SATS?

• We think the following indicators could serve as consideration points for us to turn positive on SATS -
  • Containment of the second wave of Covid-19 outbreak, or vaccine development
  • More travel bubbles being established among countries, especially for long-haul travel
  • Resumption of business and discretionary travels
  • Earlier-than-expected reopening of airport terminals. Changi’s Terminal 2 will stay closed for 18 months starting 1 May 2020 while Terminal 4 has been closed indefinitely since 16 May 2020.
• SATS adopts a prudent approach on dividend distribution although cash balance was at S$549m at end-Mar 20 (mainly from gearing up). We forecast DPS of S$0.05 for FY21F.
• There is also no major sizeable M&A plans in the near term until a clear trajectory of recovery in the aviation industry.

Reiterate REDUCE; Target Price Lifted to S$2.82, Still Based on 2x FY21F P/BV

• Inevitably, SATS's capacity will improve as travel gradually recovers but at 30x FY21F P/E, we think its valuations are ahead of fundamentals. We narrowed FY21F net loss to S$81m (previously -S$101m) on higher non-aviation revenue.
• Our Target Price of S$2.80 is based on -0.5 s.d. of LT P/BV of 2x as the company has lost some of its historical defensive strong cash and yield characteristics.
• Despite its 44% of SATS share price depreciation YTD, we think the stock may not revert to long-term mean in the near-term. We believe the improving travel statistics are already been priced in as the stock is trading above average (since 2003) of 30x FY21F P/E.
• De-rating catalyst: resurgence of severe global lockdowns.
• Upside risks to our REDUCE call is sudden halt of Covid-19 outbreak.

Source: CGS-CIMB Research - 10 Jul 2020