SATS expands Southeast Asia operations with AirAsia ground handling partnership

On the face of it, SATS’ latest venture is a promising step in its expansion into what is one of the world’s fastest-growing segments. Asia is one of the biggest travel markets in the world; industry experts forecast an average growth rate of 4.7% annually in passenger traffic over the next 20 years, and passenger traffic in the region to account for nearly 40% of all traffic globally.

According to the International Air Transport Association, Asia-Pacific will contribute more than half of the globe’s new air passengers over the next 20 years. It also forecasts that one of the world’s five fastest-growing markets will be Indonesia, which will have a market of 355 million passengers in 2026, or 235 million more passengers than today. Routes to, from and within Asia-Pacific will create an overall market size of 3.5 billion people.

Already, international air passenger demand in the region, calculated in terms of revenue passenger kilometres, rose nearly 8% y-o-y in the first nine months of this year. In Southeast Asia particularly, as the economies expand and more people begin to travel, growth has been in or near double digits. At Changi, passenger traffic for the first nine months of the year rose 5.9% y-o-y to 46 million.

Significantly, low-cost carriers in Southeast Asia account for 53% of all seats, and AirAsia is the leader. By its count, it commands nearly half of Malaysia’s international flights, and 47% of domestic flights. As Asia’s largest budget carrier, it operates more than 3,500 one-way flights a week. Last year, as a group, it carried a total of 56.6 million passengers. As such, a partnership with it could benefit SATS greatly.

SATS had formed a new entity, SATS Ground Services Singapore (SGSS), for its Terminal 4 operations. Meanwhile, AirAsia operates airport services through Ground Team Red (GTR), which in September also acquired the ground services business, along with related contracts, from AirAsia X for RM4.63 million ($1.5 million).

Under the deal with SATS, AirAsia will transfer 98% of GTR to a holding company, Ground Team Red Holdings. GTRH will then acquire 80% of SGSS from SATS, which will get an 11.4% stake in GTRH in exchange. Subsequently, SATS will acquire another 38.6% in GTRH from AirAsia, for $119.3 million in cash.

GTRH will effectively be a 50:50 JV company between SATS and Air Asia. Ultimately, AirAsia will have a 40% stake in the Terminal 4 ope rations, and SATS will have a 49% stake in AirAsia’s ground handling business in Malaysia.

K Ajith, UOB Kay Hian’s director of Asia Transport Research, argues that SATS could very well be overpaying for the expansion. The deal entails SATS’ effectively giving up a big share of its growth prospects, from the ramp-up of operations at Changi’s new terminal. In addition, the revenue-per-aircraft at the Malaysian airports is likely to be lower than out of Singapore for similar budget carriers, Ajith adds. He estimates that the SATS-AirAsia JV could handle 90,000 to 100,000 flights annually in the first two years of operations in Malaysia. “There is a possibility that SATS’ ground handling revenue will fall in 2HFY2018 or, at best, remain flat.”

Yet, SATS’ growth is no longer driven simply by volumes of ground handling services and the accompanying vagaries of the business of air travel. To be sure, gateway services, which include cargo logistics and the cruise terminal handling operations, still account for about half of SATS’ annual revenue. In the last financial year, that amounted to $750.8 million.

Over the past few years, SATS CEO Alex Hungate has reiterated the group’s strategy of leveraging its existing capabilities to diversify, and improve productivity, particularly as manpower costs rise.

The company has reinvented itself as a play on the urbanisation of the middle class in Asia, and has taken the lead in implementing digital technology in its operations to improve efficiency and customer experience. For instance, its ramp workers use smart watches with real-time tasks and updates, rather than printouts and walkie-talkies.

Meanwhile, AirAsia has also been an early adopter of technology, particularly in its push to fully automate passenger check-in processes. Both companies have “a shared vision of a digital future for aviation”, Hungate told business media, adding that it is an opportunity for growth.

SATS’ average number of employees fell from 14,396 five years ago to 13,738 in FY2017 ended March. Meanwhile, return on equity has improved from 12.7% in FY2013, to 16.7% in FY2017. Over the same period, its net profit margin has expanded from 10.2% to 15.1%. And, earnings grew to $257.9 million, at a compound annual rate of nearly 7%.

Shares in SATS have really taken off over the past couple of years, and at current levels, the stock trades at some 21 times earnings. It has pulled back a little, however, and is trading at 2.5% lower than at the beginning of the year. Even so, analysts are still relatively bullish on the stock.

DBS Group Research notes that the partnership is “positive for SATS strategywise”. It also notes that while earnings of AirAsia’s ground handling operations are not disclosed, they are believed to be profitable. DBS estimates SATS’ earnings will improve marginally, to $260 million in FY2018, but gain 3.5% in FY2019 to $269 million. The bank is keeping its “buy” recommendation on the stock, with a price target of $5.02.

Meanwhile, despite Ajith’s scepticism, UOBKH has a $5.40 price target on the stock. While SATS’ yields have been under pressure partly because of competition, analysts have noted that, as a powerful incumbent, SATS is likely to prevail.

The company is expected to report its financial results for 1HFY2018 ended Sept 30, on Nov 9.

Market expects higher dividend payout from AirAsia after deal
Its partnership with SATS effectively makes AirAsia the third ground handler at Changi Airport, with little capital investment, says UOB Kay Hian’s K Ajith. “It was what Swissport International and Aircraft Service International Group couldn’t do.” The two ground handling companies, established in Europe and the US, respectively, had secured ground handling licences in Singapore but then pulled out, owing to the lack of customers.

Meanwhile, AirAsia’s shareholders are looking forward to bigger dividend payouts. The divestment of the Malaysian ground handling operations to SATS is expected to net AirAsia a one-off gain of RM365.7 million ($117.6 million). CIMB Research analyst Raymond Yap expects this sum to be paid out in a special distribution of 11 sen a share.

Yap notes, however, that while the partnership with SATS is, on the whole, positive for the Malaysian budget carrier, spinning off its ground handling operations may lead to an increase in operating costs. “While ground handling is currently treated as part of its costs, in the future, AirAsia will have to enter into arms-length commercial contracts [with the ground handler],” he writes in an Oct 31 note. “AirAsia will have to pay [the ground handler] a profit margin.“

Still, AirAsia is expected to reap cost savings from the move, and the higher prices it may need to pay for ground handling in Malaysia could be offset by profit sharing from the joint venture (JV) with SATS, Yap adds.

Whatever the case, AirAsia group CEO Tony Fernandes has been clear about monetising the group’s non-core assets. They include its aircraft leasing unit, Asia Aviation Capital, which had been valued at roughly US$1 billion ($1.4 billion) and is on track to be sold by year-end. In August, it sold its 50% stake in pilot, crew and technician training centre Asian Aviation Centre of Excellence to its JV partner CAE for US$100 million. The group is also reportedly looking to sell its remaining 25% stake in online travel company AAE Travel, a JV with Expedia.