SATS Ltd (SGX:S58) is a leading provider of ground-handling and in-flight catering services primarily in Asia’s aviation sector. Additionally, it offers food distribution and logistics, industrial catering, and other amenities for hospitality and government agencies.
The company has three business segments: food solutions, gateway services, and corporate. It has partnerships with multiple airlines to provide catering during flights, and offers experience in planning airline menus, cabin upkeep, and washing laundry to improve airlines’ appearance.
Overview
The company is facing earnings headwinds due to weak cargo volumes primarily from the ongoing trade war and falling demand for both in-flight catering and gateway services due to the 2019 n-CoV virus which has taken the lives of 800+ and counting.
Nevertheless, SATS’s long term growth prospects continue to be promising, with the Riyadh cargo terminal concession, central kitchens in China and the growing travel demand in Japan driven by the coming 2020 Tokyo Olympics. The competitive position that SATS holds indicates that the current headwinds will be unlikely to materially impact their long-term performance.
In lieu of the coronavirus, I shall forecast a 30% qoq drop in revenue for 4QFY20. Considering that most of SATS’s expenditures are fixed (refer to chart below), net profit could just about breakeven for 4QFY20 and net profit for FY20 could be about 18% lower yoy. (Disclaimer: My math may not be right.)
SATS is currently trading at PEx21.1, around its 10 year average of around 20.7x. If we value SATS Ltd at at PE21x based on FY20F earnings, the company would have a fair value of $3.85, about 15% lower current share price of $4.42.
Company Background
With more than 60 years of operating experience, SATS had been serving and providing solutions to Singapore’s aviation industry.
They control about 80% of Changi airport’s ground handling and catering business. They also have a presence at nearly 60 airports across Asia Pacific and the Middle East. SATS subsidiaries include SATS Airport Services, SATS Catering, SATS Security Services, Aero Laundry & Linen Services, Aerolog Express, Country Foods Pte Ltd and Singapore Food Industries.
Competitive Advantage
Highly Regulated Industry
This industry is highly regulated. To apply for a license to cater these services, companies need to pass certain criteria first. SATS Ltd, with their track record and high standards, certainly has an advantage in the aviation services sector. Airlines looking to divest their in-flight catering operations would want to do business with an established and reliable player like SATS who also has a track record of working in one of the best airports in the world like Changi International Airport.
SATS Ltd is the only company that controls more than 10% market share in the Asia Pacific in-flight catering services. Thus, when M&A opportunities arises, SATS will be the preferred acquirer due to economies of scale.
Growth Drivers
1 – Changi Airport’s Expansion Plans
Yes this has been said many times by other analysts covering this company. Singapore’s Changi International Airport is in expansion mode, demand for air travel is expected to increase and traffic at Changi Airport is anticipated to grow in tandem.( read here for more info, https://www.changiairport.com/corporate/our-expertise/changi-east.html). We have also yet to see a full quarter contribution for Jewel Changi as it is only officially opened in April 2019 and with some areas not opened till mid June 2019.
2 – Acquisitions
Acquisitions is one of SATS Ltd growth strategy. The industry that SATS operate in is highly fragmented and due for consolidation. With SATS being one of the preferred acquirers due to its large market share, they have the opportunity to expand their already wide network of cargo and catering operations.
3 – China’s non-aviation food solutions
In SATS’s 2Q2020 earnings call, the management emphasized that the non-aviation food solutions such as ready-pack meals could be as large as the aviation food solutions business. An example of their non-aviation food solutions would be the upcoming central kitchen in Tianjin that is expected to commence operations in 2020, delivering c.100,000 meals for restaurant customers – Yum group, Hai Di Lao, etc.
4 – TFK Corporation
SATS’s Japanese subsidiary, TFK Corporation, is the leading airline caterer in Japan serving airlines at the Narita and Haneda airports. The recently concluded Rugby World Cup in Japan has lead to increased travel volumes to Japan and contributed to TFK’s strong performance in 2Q2020.
TFK has recently doubled its capacity with a new in-flight kitchen to better serve the 2 airports in anticipation of the 2020 Tokyo Olympics. This will most likely lead to better performance for TFK for FY2020.
Headwinds
1 – Trade War
SATS has been experiencing declining cargo volumes for FY2019 and it is expected to continue in FY2020. This is expected due to the US-China trade war and weakening global economic growth.
However, I view it as a short term headwind and cargo volume should continue to grow in the mid to long term. The high growth in the e-commerce sector should also have a trickle down effect on SATS’s cargo business.
2 – 2019 nCoV coronavirus
When China sneezes, the whole world will catch a cold. This “black swan” effect has led to China closing its borders from the world and ultimately this will have a negative impact on the global economy. SATS’s performance for 4Q20 will definitely be a bad one as 11% of SATS FY19 revenue is from Greater China region and this does not include the lower travel demand in Singapore and the rest of Asia Pacific. The question is how long they need to recover from it.
Valuation
SATS is currently trading at PEx21.1, around its 10 year average of around 20.7x. I have assumed a 18% decrease in SATS net profit for FY2020. If we value SATS Ltd at at PE21x based on FY20F earnings, the company would have a fair value of $3.85, about 15% lower current share price of $4.42.
The current dividend yield is 4.3% and 4.9% if based on my calculated fair price.
Risk
The key risk factor to my fair price is a worsening situation for the coronavirus and a prolonged trade war (likely if Trump gets reelected)
Conclusion
Despite the fall in share price since the start of 2020, Valuation still seem slightly expensive if you consider the effects of the coronavirus. Other analysts habe also cast bearish views on this company by comparing its performance during the 2003 SARS (https://research.sginvestors.io/2020/02/sats-cgs-cimb-research-2020-02-06.html, https://research.sginvestors.io/2020/02/singapore-aviation-uob-kay-hian-research-2020-02-04.html). However, the analyst has made a crucial point whereby SATS earnings recovered 80+% after the ordeal is over.
It is important not to be too affected by recency bias. SATS has a strong competitive advantage and its long term growth potential will not be affected by the short term headwinds that the company is currently facing.
However, I think that there could be better entry prices should there be an overreaction. The upcoming results release and earnings call could also shed more light on the current situation and its mid to short term outlook.
It is impossible to catch the exact bottom but this is a very good opportunity to be able to own a great company at a fair price and interested investors should keep a close lookout for new developments. I should be accumulating this company’s stock in trances should prices fall below $4.
Cheers.
Note: The Moss Piglet has family members currently vested in SATS Ltd at $4.50.