SATS

Kim Eng on  5 Jan 2012

Upgrade to Buy. SATS’ share price has been gaining momentum in the past month. We expect group revenues to be sustainable while costs may ease. The weak outlook for the broader aviation industry may bring about further M&A opportunities. Given the dearth of quality defensive stocks in the current market, we upgrade SATS to Buy with a target price of $2.70, backed by its attractive yield of 6.8%.


Revenue usually resilient. Looking at past cycles, SATS’ revenues have been sustainable even during downturns. The contributions it receives from Singapore Food Industries are virtually recession-proof due to its long-term contract with the Singapore Armed Forces. Air traffic and capacity also tend to stay relatively resilient, especially for anchor customer Singapore Airlines, even though airlines are expected to face losses due to high operating costs and lower yields. Flight schedules out of Changi Airport have also not been cut drastically.


Cost pressures to abate. SATS’ profitability has in recent years been affected by higher costs, in particular food prices. We expect these increases to taper off, if not abate in tandem with slower economic growth. In turn, this will have a positive impact on SATS’ bottom line.


More opportunities to expand. SATS recently clinched the tender to operate Singapore’s International Cruise Terminal. While contributions are not expected to be significant initially, this opens up a new market for the group. We also expect SATS to seek potential acquisition targets in the current weak aviation market environment, especially with its expanded war chest from its recent sale of Daniels in the UK.


Target price raised to $2.70. We have raised our target price from $2.43 to $2.70, pegged at an undemanding median PER of 14x FY Mar13F earnings. We have also adjusted our FY Mar13F/14F forecasts slightly in anticipation of lower costs. In a depressed market, we believe that SATS will re-emerge as a defensive play due to its resilient revenue and attractive dividend yield of 6.8% for FY Mar13.



Earnings less correlated to airlines
Lower correlation to broader aviation earnings. Despite deriving a significant percentage of its earnings from the aviation sector, SATS’earnings are clearly more defensive than the airlines’. Firstly, customers
operating out of Changi Airport, and Singapore Airlines in particular, did not cut their flight frequencies significantly during the last downturn, and indications from the current downturn show that this factor remains true as well. Secondly, SATS has diversified further into non-aviation-related revenue, which tends not to be as cyclical, if at all.

However, during the last downcycle in FY2009, SATS did face some erosion in its associate earnings due to start-up issues and other oneoff costs related to its overseas flight kitchen and ground handling operations. We do not expect the potential slowdown in the current market to be as significant, while contributions from TFK Corporation in Japan have started to kick in and should offset this impact.

Share price not immune to broad-based aviation outlook. Despite the relative stability to its earnings, SATS’ share price has been unjustifiably penalised during aviation downcycles. During the last downturn in 2009, its valuation fell to a low of 1x P/BV. Its PER also slipped to just 8x, without significant erosion in core earnings.

Defensive qualities should be recognized. In our opinion, SATS has the potential to be re-rated as a more defensive play on the strength of its relatively stable earnings and healthy dividend yield – a safe haven
versus the cyclical stocks.

In recent years, SATS’ dividend payout ratio has been at around 80% of earnings, and only dropped to 74% when earnings contracted in FY09. FY11 also saw a special dividend which brought the payout ratio to 100%. Given this strong historical track record, the continued cash generated from operations and the need for better capital management following the sale of Daniels, we believe that the 80% payout ratio is
easily sustainable for FY12 and beyond.


Cruises to the finish line
SATS wins ICT bid. Just last month, SATS won the tender to operate the S$500m International Cruise Terminal (ICT). The bid was made in conjunction with its Spanish cruise terminal partner, Creuers Del Port
de Barcelona. The duo beat out competition from the Singapore Cruise Centre (SCC), the incumbent cruise port operator in Singapore, which currently operates the existing facilities at HarbourFront and Jurong
Port. Part of the reason SATS succeeded was that it had roped in Creuers, Europe’s largest cruise port operator which currently manages five cruise terminals in Barcelona. The SATS-Creuers consortium, a
60:40 joint venture, will operate the ICT on a 10-year lease, which could be renewed for another five years.

Against the odds, no less. The ICT will finish construction shortly and is expected to start operations in 2Q12. Although we had pegged SATS’ chances of winning the bid at around 30%, the group was
reasonably confident of securing the contract. It should be able to hit the ground running as it currently operates a Cruise-Fly handling service with Royal Caribbean Cruises and Star Cruises. Both are
expected to be major users of the ICT.

Not a significant contributor for now, but opportunities are there. For its 60% stake, SATS has already paid up S$3.6m in initial invested capital. The consortium expects to spend only just about $1.2m for its
initial capex. Revenue, while not expected to be transformational at this time, will be derived from check-in and handling services charged to the cruise liners, as well as rental of retail space within the terminal. There
are also cross-selling opportunities, with Singapore Food Industries being able to provide chandling (ie, provisioning) services to the cruise operators.

Consolidation in the cruise industry ahead. Both the current cruise terminal at HarbourFront and Jurong Port will continue to operate for now. However, the longer-term viability for Jurong is in doubt as it was
meant as a stop-gap solution to handle larger cruise ships that were restricted from utilising the HarbourFront Berth. The ICT was built as a direct solution to this. Going forward, we also question the viability of HarbourFront for cruise liners, since it makes more sense to consolidate all cruise operations at the ICT. We therefore speculate that SATS may be in a position to buy over its rival bidder SCC and bolster its expertise in cruise operations. It recently sold its UK subsidiary Daniels for S$300m, and its firm cash
position will allow it to undertake such a bid.

Singapore as regional hub. Singapore has set its sights on being a major destination and hub for cruise operators plying the region, hence the go-ahead for the ICT. In 2010, the Republic saw over 1m cruise
passengers.