SATS - UOB Kay Hian 2022-11-10: 2QFY23 Core Losses Narrowing; Likely To Return To Profitablity Next Quarter

• Excluding government reliefs, one-offs and professional fees related to the WFS deal, SATS’ core net loss stood at S$5m-10m in 2QFY23, a meaningful improvement over 1QFY23’s ex-relief core net losses of S$31.9m.
• We expect SATS to return to positive core profitability in the next quarter as we head into the year-end peak travel season.
• Management has updated its financing plan for the WFS deal to use only straight equity and more debt.
• Maintain BUY recommendation on SATS with an unchanged target price of S$3.08.

Meaningful improvement in SATS' core profitability.

• SATS (SGX:S58) recorded headline net losses of S$9.9m in 2QFY23 (1HFY23: S$32.5m losses). Stripping out a one-off disposal gain of S$1.9m and government reliefs of S$11.4m, SATS’ 2QFY23 core net loss stood at S$21.6m in 2QFY23.
• 2QFY23 performance was also affected by the recognition of S$15m expenditure of the professional fees related to the WFS acquisition. Excluding this expense item, SATS’ 2QFY23 ex-relief core net losses would have been S$5m-10m, a meaningful improvement over 1QFY23’s ex-relief core net loss of S$31.9m.
• Passenger business volume continued to recover; a slight dip in air cargo volume. In line with the aviation sector’s recovery, SATS’ business volume continued to recover in 2QFY23 – the volume of flights handled, meals served and passengers handled rose 20.0%, 28.7% and 29.9% q-o-q respectively.
• Cargo tonnage handled declined 2.6% q-o-q, likely due to a normalisation of the air cargo business from the pandemic high and the slower near-term demand amid the weakening macroeconomic outlook.
• Group revenue rose 14.2% q-o-q to S$429m in 2QFY23, driven by q-o-q higher revenue across all regions.

Expecting a turnaround for SATS in 3QFY23.

• We expect SATS to return into core profitability next quarter, as we head into the year-end peak travel season. In its home market Singapore (which accounted for 80% of SATS’ 1HFY23 revenue), passenger volume at Changi Airport is on track to reach about 75% of pre-pandemic levels in 3QFY23 by our estimate, compared to about 57% in 2QFY23.
• The expected higher passenger volume, together with operating leverage (labour hiring is expected to taper off as SATS is said to have recruited enough to support the year-end peak season) should help return SATS to core profitability.

Using rights issue and term loans to finance WFS; net gearing to hit 90% post transaction.

• During the 2QFY23 analyst briefing, management updated that SATS intends to finance the S$1.8b equity portion of the WFS deal with a rights issue not exceeding S$800m and make up the remaining balance with internal cash (about S$320m) and term loans (about S$700m).
• Together with WFS’ existing debt (S$1.4b-1.5b) which SATS will assume, SATS’ post-transaction net gearing is expect to reach around 90% by our estimate, compared with its net cash position as of end-1HFY23. Management is confident that the operating cash flow of SATS and WFS will cover the interests and principal repayment.

Change in SATS' investment thesis.

• SATS used to be favoured by the market as a stable yield play (with 70-80% dividend payout ratio) backed by a strong balance sheet. After the WFS transaction, we expect SATS to become more of a balance of growth and yield.
• With the elevated net gearing, SATS is likely to moderate its dividend payment and utilise more of the surplus operating cash flow to pare down the debt.

SATS – Earnings forecast revision & recommendation

• We cut our FY23 net profit estimate to S$15.7m (from previously S$64.5m), as we:
  1. fine-tune our expectations for SATS’ profit recovery trajectory, and
  2. include S$41m expenditure of the professional fees related to the WFS deal (S$19m already incurred in 1HFY23).
• We keep FY24-25F forecasts intact.
• Maintain BUY recommendation on SATS with an unchanged SOTP-based target price of S$3.08. We value SATS’ existing businesses on a standalone basis using DCF and then incorporate the valuation impact of WFS. We conservatively value WFS at 7x EBITDA, in view of the rising interest rate environment and the uncertain global air cargo outlook in the near term.
• No strong near-term catalyst. Investors in SATS need to adopt a medium-to-long term view.
• Medium-term catalysts could include:
  • SATS successfully integrating WFS and delivering the forecasted synergies, and
  • recovery of global air cargo outlook.
• Key risks:
  • deteriorating global air cargo outlook;
  • air traffic recovery losing steam beyond FY23; and
  • failure to pass down inflationary cost pressure to customers.