In the world of investing, there will be a small group of investors who believe in buying beaten down stocks as they see value in them. COVID-19 is an unprecedented event that affected most of the industries and the aviation industry is one of them that is severely impacted by the pandemic.
According to the statistics provided by Changi Airport, Year-To-Date Changi Airport’s passengers movement is at 11.1 million, a significant decrease of 66% from 2019 June YTD of 33.23 million. In addition, the International Air Transport Association foresees that air passenger numbers won’t return to pre-covid levels till 2024.
So what exactly does this group of investors see in buying beaten down stocks in the aviation industry such as SATS or Singapore Airlines that others don’t? In this post, I will challenge myself in analysing SATS, an alternative investment to future recovery in aviation, and to understand the rationale behind buying such stocks.
Since its listing in 2000, SATS has become Asia’s leading provider of food solutions and gateway services. SATS has presence in 65 locations in 14 countries across the Asia Pacific, UK, and Middle East and handled 84.6 million passengers, a significant increase from 22 million passengers in 7 countries it recorded in 2000.
SATS classifies its business into two business segments – namely Food Solutions and Gateway Services. In the latest financial year, Food Solutions contributes 55% of overall revenue while Gateway Services contributes the remaining 45% of overall revenue.
As SATS is formerly known as Singapore Airport Terminal Services, it is understandable that aviation contributes 82.7% of its revenue while the remaining 17.3% of its revenue are from non-aviation such as commercial catering or Institutional Catering. SATS has been trying to diversify its revenue stream into non-aviation. Compared to the previous financial year, contribution from Aviation decreased from 85.5% to the current 82.7%. It is definitely an uphill task to diversify its revenue into non-aviation but it is commendable that the management is making some progress.
Under its food solutions business, SATS provides services such as aviation, commercial and institutional catering, food production and distribution capabilities, as well as central kitchens for food service chains and institutions. You may refer to their website for more information.
Under its gateway services business, it encompasses airfreight handling, passenger services, ramp handling, baggage handling, aviation security services, aircraft interior and exterior cleaning, as well as cruise centre management. SATS is responsible for handling seamless flow of passengers, flights and cargo at airports they operate in. For more information on its gateway services business, you may refer to this website.
SATS has not been growing its topline for the past 8 years. It is quite disappointing that SATS did not continue to grow its revenue consistently. As seen from the above image, revenue for the past 8 years have been range bound at $1.6 billion to $1.9 billion. Revenue stood at $1.685 billion in 2012 and grew 8% to $1.819 billion in 2013. For the next 3 years, revenue slid and bottomed in 2016 and has been on an upward trajectory since 2017, albeit at a slower growth rate. The lacklustre performance in revenue was due to the divestment of some of its food solutions business.
Even though SATS has not been growing its topline very much for the past 8 years, net profit grew more than its revenue except in 2020 due to the pandemic. Excluding 2020, SATS grew its revenue by 8% or $143 million from 2012 to 2018 while net profit grew 52% or $90 million during the same period. This is because SATS has been managing its expenses well where net profit margin increased from 8.49% in 2012 to 12.28% in 2019.
As net profit grew, so will EPS. Excluding 2020, EPS grew from 15.4 cents in 2012 to reach a high of 23.4 cents in 2018, an increase of 50% in 7 years. Judging based on the payout ratio against EPS, SATS has been giving out a sustainable dividend since 2013. There has not been a year except 2012 where DPS is higher than EPS. 2012 was an exceptional year where The Board proposed a special dividend of 15 cents which brought the total dividend to be 26 cents, a payout ratio of 168.6%.
Do note that SATS had an extremely high payout ratio of close to 100% in 2013. However, management has been very cautious in growing its DPS at the rate its EPS is growing as shown on the later part of the chart.
In the latest financial result, the company has decided not to give a special dividend so as to preserve more jobs in this crisis and capabilities to support its clients as aviation volumes begin to recover, and to pursue opportunities outside of aviation.
I believe the reason why SATS topline has not been growing is because its food solutions segment has not been growing since 2012. Revenue from food solutions grew 8% or $88 million in 2013 to $1.165 billion but slid for the next 5 years and bottomed in 2018 at $988 million. The slide was mainly due to the divestment of some of its food solutions business. It has since picked up in the past 2 years where revenue grew 8% to hit $1.071 billion in 2020.
On the other hand, SATS has been growing its gateway solutions at a faster rate than its food solutions. Revenue grew 44% from $603 million in 2012 to $869 million in 2020, contributing 45% of total revenue in 2020, an increase from 36% in 2012.
The two charts above show the exposure SATS is exposed to the aviation sector. Exposure to the aviation sector has maintained above 80% for most of the years. Management has no plans in diversifying away from the aviation industry in the wake of the pandemic, as shown in their recent acquisition in Monty’s Bakehouse, an aviation food innovator. SATS hopes that with this acquisition, food solutions for aviation customers can be enhanced and support growth into new customer segments.
Balance Sheet and Cash Flow
As SATS is a cash generative business, it has been able to produce positive net operating cash flow of more than $240 million each year. The decline in cash and short term deposits even though borrowings were stable can be attributed to cash used in investing and financing activities.
In 2020, the Group has decided to draw down existing credit facilities to build up its liquidity position during the pandemic. Borrowings increased significantly from $95.4 million in 2019 to $414.9 million in 2020 after it took up term loans and issued $200 million notes due in 2025 from its $500 million multicurrency Debt Issuance Programme. Despite the significant increase in borrowings, SATS is still in a net cash position, albeit at a lower amount compared to previous years. This also resulted in cash and short term deposits to increase $549.2 million where its net cash stands at $134.3 million.
Looking at the past 5 year of Cash Flow statements, SGX is a cash generative business that produces strong operating cash flow ranging from $240 million to more than $310 million.
With the Cash Flow statements, we are able to calculate Free Cash Flow to check against whether the dividend payout is sustainable. Even though dividend payout ratio based on EPS is sustainable, it is important to note that dividend payout for most of the years based on FCF are not sustainable. Take for example in 2018, where it paid $190.3 million in dividends, its FCF stands at $146.3 million, a payout ratio of 130%. In 2020, it paid out $212.5 million in dividends, when its FCF is only at $168.4 million, this is a payout ratio of 126%. For payout ratio above 100%, a company has to either draw down from its cash at bank or to take up debt to fulfil the payment of dividends.
1QFY21 Earning Result
SATS reported its business update for the first quarter ended 30 June 2020 on 24 August 2020. The result was better than what management had guided of ranging from $50 – 70 million loss on 30th April 2020 and in line with the guidance given when FY20 results were released.
Strict lockdowns and travel restrictions as the cause of the pandemic have resulted in demand for air travel to decrease significantly in the first quarter of the FY. With the reduction in demand for air travel, passenger and cargo movements have declined significantly, thus impacted the performance of SATS where aviation contributed more than 80% of its revenue in the previous FY.
Group revenue fell 55% YOY to $209.4 million. Revenue from Gateway Services decreased by $151.7 million or 67.9% YOY to $71.6 million while revenue from Food Solutions dropped by $105.5 million or 43.7% to $135.9 million.
Comparing the result based on Industry, Aviation revenue slumped $298.2 million or 73% YOY to $110.6 million. Over the past quarter, SATS had been signing up new customers for Food Solutions, which include fast food chains and Sysco, a food and non food product distributors. In addition, SATS also introduced new brand and product extensions. As a result of growing its business beyond aviation, non-aviation revenue grew 73.3% to $96.9 million. However, we are not sure whether the growth is one off and time will tell if it is so.
In the previous quarter, SATS continued to draw down existing credit facilities to build up its liquidity position. Borrowings increased $256.5 million to $671.4 million from $414.9 million 2 quarters ago. Despite the increase in borrowings, SATS remains in a net cash position, albeit at a lower amount of $52.1 million, compared to net cash position of $134.3 million 2 quarters ago.
Impact of Covid-19 to SATS
As announced by the Government recently, the main support that SATS will be receiving will be the Jobs Support Scheme. This scheme is meant to provide wage support to help enterprises retain their local employees during this period of economic uncertainty. The Government will co-fund the 75% of the first $4,600 of gross monthly wages per local employee for 9 months. In the latest FY, staff cost expenses improved $136.9 million as it received government reliefs of $61.7 million, among other reasons.
As announced by the Government on 17 August 2020, JSS had been extended by up to seven months to cover wages paid up to March 2021, bringing the total wage support to 17 months for most sectors. The additional support will be paid out by March and June 2021. Under the extended scheme, the Government will co-fund 50% of the first $4600 of gross monthly wages of every local SATS employee.
I believe the key data to focus on in the coming months and quarters will be the traffic statistics of Changi Airport since the majority of its revenue comes from Singapore and Aviation business. Since June 2, travellers are gradually allowed to transit through Changi Airport. At the time of writing, Changi Airport had released its traffic statistics for July. Passenger movement doubled in July from 48.2k passengers movement recorded in June to 86k in July. However, it is still down 98.5% compared to a year ago.
IATA has downgraded its revenue passenger kilometers forecasts. IATA has forecasted that 2019 RPK level will only be achieved by 2024 and that 2021 RPK level will be 36% lower than 2019 level, though an increase of 75% YOY from 2020. Furthermore, IATA has also disclosed its range of outcomes for global aviation. In its base case, IATA has forecasted and expected that air passengers will only return to 2019 level in 2024. In its downside scenario, IATA has forecasted that air passengers will only recover to 75% of 2019 level in 2024 while its upside scenario is that air passengers will grow to 110% of 2019 level in 2024. In summary, IATA believes that long term growth in aviation is still intact though growth will be delayed.
If pandemic did not occur, SATS would have experienced a growth rate of at least 5% per annum in countries where it has presence till 2037. In addition, IATA has estimated that the total market size of Airline Catering and Ground Handling will increase at least 8.5% CAGR and 6.4% CAGR from 2017 to 2023 respectively. This represents a larger total addressable market opportunities which might translate into better earnings for SATS in the long run. This will benefit its food solutions and gateway solutions in the long run as growth in both businesses are mainly driven by passenger volume, flights handled.
As for Singapore where it contributes 80% of overall revenue, growth in Singapore will mainly depend on the construction of Changi Airport Terminal 5 where it will increase the passenger handling capacity to 135 million, a significant increase from 85 million in 2018. Due to the wake of the pandemic, authorities have decided to conduct a study on the future of aviation and this resulted in delay in the construction of the fifth terminal at its Changi Airport for at least two years. Overall, authorities are optimistic that air travel growth will still be intact but delayed.
With the release of the latest quarterly result, we now have a better understanding of how the pandemic has impacted. We now understand the damage the pandemic has brought to the business of SATS and how much impact to its aviation revenue, cash flow and balance sheet. For aviation revenue, I believe that in the coming quarters will be as ugly as the latest result but QOQ should show improvement as Governments slowly lifts their travel restrictions. As for non-aviation revenue, it is uncertain whether the 73.3% growth YOY will sustain in the coming quarters.
I understand why there will be a group of investors who believe in buying beaten down stocks such as airlines stocks or stocks that are severely impacted by the pandemic. They believe that the capital appreciation they will get once share price recovers will be great.
There’s no right or wrong answer in investing in such companies as investors have different beliefs and one hopes that their strategy or thesis will work at the end of the day. In my opinion, aviation will eventually recover but it is a matter of when it will happen so I believe that it will definitely take a longer time than expected for the share price to even recover back to $4.
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