• COVID-19 pandemic precipitated a divergence between recovery of SATS (SGX:S58)’s cargo (by 1QFY21) and passenger/ inflight catering services (post-FY23F).
• After 3 consecutive quarters of losses, we expect SATS to turn around in the upcoming 3QFY21 (Oct 2020 to Dec 2020) earnings announcement, with a profit of ~S$3.5m, backed by stronger cargo revenue and Job Support Scheme (JSS).
• Backed by minimal net gearing (4-5%), we expect SATS to accelerate in its M&A efforts. Upgrade SATS from Hold to ADD with Target Price S$4.30.

Structural Positives for Air Cargo Industry

• Changi’s freight volume grew 5.5% m-o-m in Dec 20 to 147.7k tonnes, recovering to ~84% of pre-COVID-19 level (as of Dec 19). Similarly, SIA’s cargo volume grew by 20% q-o-q to ~70m kg in Oct-Dec 20.
• In its preliminary 4Q20 results, DHL’s FY20 EBIT of €4.8bn exceeded its guidance of €4.1bn-4.4bn; it raised its mid-term EBIT and FCF guidance to a y-o-y growth for 2021F and 2022F on structural B2C and ecommerce growth.
• We believe the strong cargo trend is likely to continue through 2021F on the back of shortage in capacity from the loss of available passenger aircraft belly cargo space.

Cargo Revenue Could be 30% Stronger Vs Pre-COVID-19 by FY23F

• Pre-COVID-19, gateway services revenue was largely dominated by ground handling, making up about 35% of SATS’s group revenue, while cargo handling was about 10-15%. We now factor in an average h-o-h growth of 25% for cargo revenue in 2HFY21F, which would lead SATS to reach pre-COVID-19 revenue level by 1QFY22F, after which, we pen a 10-15% q-o-q growth for the rest of FY22F, before slowing to a flat 2% q-o-q in FY23F, for an annual revenue of S$312m (or ~30% above FY19 levels).
• Cargo handling is less labour intensive and typically commands a mid-teen EBIT margin. Therefore we think SATS’s operating margin could return to ~10% by FY23F (from 0% in FY21F).

Cold Chain Capabilities

• SATS’s coolport in Singapore handles about 250k-300k tonnes p.a. of temperature-sensitive goods. It operates 18 temperature-controlled cold rooms, with adjustable temperature zones from -28˚C to +25˚C, with product segregation capabilities. Typically, the 2 ˚C to 8˚C range is for food handling, while the 15˚C to -25˚C range is for pharmaceutical products, including vaccines (-25˚C).
• In addition to Singapore, SATS’s cold chain capabilities span 10 other locations, with Transom Oman and India having the biggest operating areas. So far, we believe five out of these locations are Center of Excellence for Independent Validators in Pharmaceutical Logistics (CEIV Pharma) certified by IATA.
• We believe SATS’s pharmaceutical handling revenue is still immaterial for now. Overall perishables (which use cold chain facilities) make up ~30% of SATS’s cargo tonnage. Within perishables, pharmaceuticals (higher yield) make up about 30%. We estimate overall pharmaceutical handling to be about 4-5% of SATS’s EBIT. Currently, SATS does not handle the last mile delivery of any vaccine.

Inflight Catering Structurally Challenged

• Changi Airport flights and passenger movements are grinding slowly to ~23% and 2% of pre-COVID-19 levels, respectively. IATA reported that international passenger demand in Nov 20 was slightly worse m-o-m due to new lockdowns, which weighed on travel demand.
• We now forecast ground handling to reach 52% and 75% of pre-COVID-19 level in FY22F and FY23F, respectively. As companies direct their efforts towards remote work, business travel has come to a standstill. This structural shift means inflight catering volume is unlikely to fully recover in the next two years.
• We expect recovery to 23%/35% of pre-COVID-19 levels for SATS’s aviation food catering services by FY22F/FY23F.

Ready for M&As

• Given its stabilising cargo business and strong cash position, we believe SATS could start to accelerate its M&A efforts. Its last acquisition was in Feb 20 — an innovative sustainable packaging company, Monty’s Bakehouse, for S$34.9m.
• As of 1H21, SATS’s net cash stood at S$132m, with a cash balance of $818m. We estimate SATS could end FY21F with a minimal ~4% net gearing, backed by its cash-generating cargo business.

Expect a Turnaround to S$3.5m Profit in 3QFY21F, Upgrade SATS to ADD

• We expect SATS to report a 3QFY21F (Oct 2020 to Dec 2020) net profit of S$3.5m, from a loss of S$33m in 2QFY21. (SATS will release its 3QFY21 business update on 10 Feb after market hours.
• Re-rating catalyst: earnings-accretive M&As.
• Key risk: a new wave of the pandemic.
• We think the downside for SATS share price is limited, with the commercialisation of the COVID-19 vaccine.

Source: CGS-CIMB Research - 1 Feb 2021