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Diversification, productivity improvements to help SATS weather the Covid-19 storm

Uma Devi
Uma Devi • 5 min read
Diversification, productivity improvements to help SATS weather the Covid-19 storm
Although SATS's 4QFY2020 earnings are likely to fall by a “larger degree, analysts choose to remain optimistic on a possible comeback after virus fears ease.
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SINGAPORE (Feb 17): SATS is one the companies that has to brace itself for the impact of a rapidly escalating Covid-19 situation.

In its earnings call on Feb 13, SATS says it is taking “proactive steps” to mitigate both the impact and risks of the epidemic, which has caused a significant reduction in air traffic in China. Apart from China, the decline in regional travel is also expected to affect SATS’s overseas arms in Japan, as well as associates throughout Southeast Asia and the Middle East.

For 3QFY2020 ended December, the group booked earnings of $59.3 million, some 13.9% lower than $68.9 million in the year before. However, SATS defied analysts’ expectations with a 17.6% growth in revenue to $545.6 million spearheaded by growth across both its food solutions and gateway services segments.

See: SATS posts 13.9% drop in 3Q earnings to $59.3 mil on higher expenses

But market watchers caution that the worst is not yet over, and that the group’s 4QFY2020 earnings are likely to fall by a “larger degree”, with the near term outlook likely to be marred by regional aviation headwinds.

DBS Group Research has slashed its FY20-22F earnings by 2-12% to factor in the key impact one of SATS’s primary revenue contributors - Changi Airport. In a Friday report, DBS analyst Alfie Yeo notes that 82% of the group’s revenue in FY2019 was from Singapore alone.

“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,” shares Yeo.

“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,” adds Yeo.

Similarly, Phillip Capital has also slashed its earnings forecast by 23% for FY20E in anticipation of revenue declines from a dip in aviation traffic and closure of restaurants in China.

While analysts expect the segment to be rattled over the next quarter, UOB Kay Hian analyst K Ajith believes that the market has already factored in most of the known negatives.

“The key uncertainty is whether the impact would be short-lived or extend beyond Mar 20. The
Singapore Tourism Board has assumed that tourist arrivals will decline 25-30% in 2020 due to Covid-19. We believe the street has not factored in such a scenario,” says Ajith. “We have factored in an 11% y-o-y decline in pax throughput at Changi Airport for 4QFY20220,” he adds.

But although investors might shy away from SATS for the time being, analysts are banking on a longer-term turnaround, which could then dole out profits to investors who were willing to take the risk.

For one, SATS’s strategy of diversifying into different countries and revenue streams is poised to boost its recovery after the virus wanes.

Phillip Capital’s Paul Chew notes that the group’s revenue from Japan rose 10.6% y-o-y in 3QFY2020 to $70.5 million, making it the third largest geography for the group after Singapore and Greater China.“SATS has invested in sufficient capacity to benefit from increased slots at the Haneda airport,” notes Chew.

DBS’s Yeo highlights how non-aviation revenues constituted 14% of the group’s revenues in FY2019. For instance, Yeo identifies how the group has taken to providing more institutional catering through supply contracts with corporate clients and at events.

“[SATS] has a 21-year catering and F&B services contract with the Singapore Sports Hub from 2014, through a 70-300 joint venture with global hospitality company Delaware North Companies,” says Yeo.

“SATS also has a Kunshan central kitchen which supplies food products to customers in fast casual restaurants as well as the aviation sector,” he adds. In addition, Yeo opines that increasing gateway revenue traction spearheaded by the Marina Bay Cruise Centre could also help to diversify the group’s revenue streams away from the aviation sector.

Secondly, SATS has made attempts to improve its productivity through cost reduction and automation. In its latest earnings call, SATS had revealed that some 73% of its expenses were attributed to staff and raw material costs.

But that is expected to be reduced soon, as the group implements initiatives to improve productivity and optimise the use of human labour with automation. Efforts include automated tray assembly lines and Autonomous Guided Vehicles (AGVs) in food operations.

“Continued cost reduction through automation and staff productivity has helped to keep costs under control. Value added per employee improved from $69,200 in FY2011 to $85,620 in FY2019,” says Yeo.

Finally, as troubled stocks turn to the upcoming Singapore Budget to be delivered on Feb 18, SATS is no exception. UOB’s Ajith identifies the Budget as a potential “buying catalyst” for the stock.

“There is a strong possibility that Budget 2020 might offer similar relief along with lower licensing fees for airlines and other operators at Changi Airport. This could buffer some of the impact from lower visitor arrivals,” says Ajith.

DBS and UOB Kay Hian are maintaining their “hold” calls on SATS with target prices of $4.46 and $4.80.

Phillip Capital, however, has downgraded SATS to a “neutral” from the previous “accumulate” recommendation with a target price of $4.45.

As at 11.45am, shares in SATS are trading four cents higher, or 0.9% up, at $4.47. This translates to a price-to-earnings (P/E) ratio of 22.0 times and a dividend yield of 4.3% for FY20F according to DBS valuations.

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