SATS is a SGX stock which I have always admired because of its historically strong business performance. The company is a leading provider of gateway services and food solutions, with the major bulk of business mainly in the aviation sector. Recently, the share price of SATS experienced a loss of form. What is the situation? Has the management lost the plot?
Since the announcement of the 1QFY2018 financial results in 21 July 2017, the share price experienced a major bout of decline. From $5.10 to $4.60, there was a drop of almost 10%. Technically, this represented a correction for SATS share price. It is only lately that this counter started to recover and climbed to $4.77 on 3 November 2017.
It appears to me that investors had decided to punish this counter for delivering quarterly profit of $57.3 million in Q1FY2018, a decline of 10.6% compared to prior year. But I think it is not justified because in the previous year, the profit was bolstered by the sale of the Senoko plant, which provided a non-operating gain of $9.3 million.
In fact, SATS performance should be considered resilient because current quarterly results excluded one-off items like disposal of assets. Revenue and operating profit remained flat, at $426.5 million and $53.5 million respectively.
The operating environment continued to be challenging for SATS because it is in the mid-level value chain. As a service provider to the airlines, it faces price pressure from airlines. Thus, if the airline industry suffered from low yields, business will be affected as well. Take for example, the operating margin has shrunk 0.3 percentage points to 12.5% for the current quarter.
With a market share of 80% at Changi Airport, SATS’ main competitor is dnata. A few years ago, the two companies had entered into price war and this led to the players slashing costs for servicing the airlines. Although the price war is a happy problem for airlines, this is not sustainable for the industry because in a bid to secure contracts, the players often have to slash costs zealously and profit margins would be razor thin. In my opinion, a better strategy should be to provide better value for airlines through superior customer service, innovative product offerings and exclusivity. In today’s context, companies are more than willing to pay a premium for differentiating factors that could enhance business revenue.
However, the balance sheet remained very strong. With current assets of $928 million versus current liabilities of $421 million, SATS enjoyed net current assets of $507 million. Debt-to-equity ratio remained healthy at 0.06 times. Cash and cash equivalent amounted to a whopping $544.6 million. With so much cash on hand, SATS certainly got a huge warchest to mount a slew of acquisition or partnerships to engineer future growth.
But then again, its business model generates a lot of cash and therefore, it does not need to dip into its cash holding for investments. For 1QFY2018, the free cash flow generated was $27.7million after including the capital expenditure of $18.9 million.
Going forward, I hope management can diversify revenue sources and reduce reliance on the Singapore market. Currently, the major bulk of the revenue is still derived from Singapore. For 1QFY2018, revenue from Singapore was $350.5 million, while revenue from the other markets was only $76 million.
Merger and acquisitions allow for scaling of the ground handling business in Asia. With the opening of Changi Airport Terminal 4, the recent partnership with AirAsia is an interesting project.
SATS has formed a new ground handling entity, SATS Ground Services Singapore Pte Ltd (SGSS) to serve customers at Changi Airport’s new Terminal 4. Under the terms of the partnership, SATS will acquire a 50% interest in Ground Team Red Holdings Sdn Bhd (GTRH) in exchange for SATS’ 80% stake in SGSS and aggregate cash consideration of SGD119.3 million (approximately MYR 372.2 million).
GTRH will be renamed SATS Ground Team Red Holdings Sdn Bhd, which will be the 50:50 joint investment vehicle of AirAsia and SATS that will hold stakes in both its Malaysia and Singapore subsidiaries, Ground Team Red Sdn Bhd (GTR) and SGSS respectively. AirAsia will effectively own 51% of GTR and 40% of SGSS while SATS will effectively own 49% of GTR and 60% of SGSS. Both companies will also be responsible for growing the ground handling business in their respective markets and will explore expansion into Indonesia, the Philippines and Thailand in the near future.
I like this project because SATS can easily afford the cost given the strong balance sheet and free cash flow. More importantly, the new partnership will give SATS, which already owns a 49% stake in the largest flight caterer in Malaysia, Brahim’s SATS Investment Holdings Sdn Bhd, access to the Malaysian ground handling market. The partnership would enable SATS to gain access to AirAsia’s ground handling operations at 15 airports in Malaysia. Currently, Singapore and Japan are the two main sources of revenues, in terms of geographical location.
Another aspect I like about this venerable company is the investment moat. The gateway arm offers a full of services, consisting of passenger services, apron, security, air cargo and flight operations and load control services. They also operate the Singapore cruise terminal, Marina Bay Cruise Centre. As Changi Airport grows its air hub, the company will benefit as well because it is the leading player in the Singapore market. But what I would like to see in future is that the management would expand into other air hubs in Asia and export the business model to overseas markets to capture growth in Hong Kong and Japan. Asia Pacific would continue to be the most attractive region in terms of aviation growth as airlines expand aggressively.
Since listed in 1999, management has been rewarding shareholders with dividend payouts every year. The ordinary dividend payouts for the past 10 years had been minimum 10 cents, with additional special dividends being given out in a few years. Because of this, I would think that this is a good dividend stock to hold. I also like the management for growing the company prudently through careful acquisitions.
In my point of view, the current correction in share price is a healthy one and investors should not be alarmed by the decline. Since the Great Financial Crisis, this stock has gone on a massive bull run and it is inevitable that “what goes up must come down”.
In light of the resilient business fundamentals, I don’t see anything wrong with SATS and hence the price correction could present buying opportunities for investors. Not vested in this counter but will continue to monitor the company’s performance.
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