As travel restrictions to curb the spread of Covid-19 came into full force in 2Q this year, demand for air travel had plunged to a dramatic low, hurting not just airlines but also SATS, which provides food solutions and gateway services to the aviation sector. Fortunately, the company’s non-aviation business was a bright spot.
In a business update on Aug 24, SATS reported that its non-aviation revenue surged 73.3% y-o-y to $96.9 million in 1QFY2021 ended June 30. This was largely attributed to Country Foods, which became an indirectly wholly owned subsidiary of the company last year. SATS had acquired the remaining 49% stake it did not own in Country Foods from food company BRF for $17 million. Country Foods was previously known as SATS BRF.
According to SATS president and CEO Alex Hungate, Country Foods had seen higher trading and distribution volumes to retail channels and the food services industry here and overseas. This was partly attributed to the expansion of Farmpride’s range of products to include ready-to-eat frozen food. New products, such as Spanish bakery brand Europastry, helped too. “Maybe people were eating more doughnuts during the circuit breaker period,” Hungate quips.
While the bump in non-aviation revenue is a positive, it was not enough to offset the declines in the gateway services and food solutions businesses. During the quarter, SATS handled only 200,000 passengers and served 9.4 million meals, compared to 22.5 million passengers and 19.3 million meals a year ago. Similarly, it handled only 6,550 flights and 221,000 tonnes of cargo, compared to 91,500 flights and 452,000 tonnes of cargo a year ago.
As a result, aviation services revenue plunged 72.9% y-o-y to $110.6 million. This led total revenue down 55% to $209.4 million. Compared to the preceding quarter, the company’s revenue was down 51.7%.
To make matters worse, SATS’s associate and joint venture companies also registered lower contributions as they, too, were affected by the impact of Covid-19. SATS’s share of revenue declined 61.7% y-o-y to $69.6 million. Its share of losses amounted to $31.4 million compared to share of earnings of $14.6 million a year ago.
As a result, the company reported its second straight quarterly loss of $43.7 million during the quarter. This was wider than the loss of $6.3 million in 4QFY2020.
Accelerating diversification
The aviation sector has been the mainstay of SATS business. This includes airline catering, airfreight handling, passenger services, ramp handling, baggage handling, aviation security services, aircraft interior and exterior cleaning. But this narrow focus has made SATS vulnerable to this unprecedented slowdown in global aviation traffic.
Back in 2014, Hungate had already set about leveraging SATS’s existing capabilities into new growth areas. The company’s inflight catering expertise was parlayed into large-scale food manufacturing and distribution, via tie-ups with major food companies Wilmar International and BRF.
Its ground-handling competence, too, was leveraged into cold chain handling of perishables — from flowers to meat and drugs — and a high-tech e-commerce hub. Moreover, the huge amounts of data amassed from its airport services helped it offer travellers a seamless, customised shopping experience from air to ground.
Covid-19, if anything, has only served to underscore the importance of SATS’s diversification into non-aviation sectors. Citing the International Air Transport Association’s (IATA) bearish forecast, Hungate notes global passenger traffic will not return to pre-Covid-19 levels until 2024. This means that airline catering and gateway activity are likely to stay dampened too.
In view of that, SATS’s push into non-aviation sectors remains a vital cog of the company’s strategy, says Hungate. He points out that SATS’s China business has grown its customer base quite aggressively. In Southeast Asia, the acquisition of Country Foods has allowed the company to achieve faster growth in the food services and retail industry, he says. The company is also making “good progress” in Japan’s retail industry. Furthermore, some of SATS’s associates are making the same pivot, taking the company’s lead as an example.
“We are pleased to have the basis to make that move [into non-aviation sectors]. It would be difficult to do it from [scratch]. We are putting a considerable amount of resources now into accelerating that,” says Hungate.
The diversification into handling of perishables and medical supplies has also gone well with relatively low-price sensitivity. Hungate believes that air freight for such items will continue to grow ahead post Covid-19.
“It turns out that Covid-19 has accelerated that trend. So, we are seeing a higher proportion of the cargo for [those items],” he says. “The yields from these are higher than general cargo. We feel that our pricing power is higher in those categories because our services are more differentiated from the competition across the region.”
Diversification aside, Hungate says the company remains focused on keeping costs down given how the outlook is weak. During the quarter, its operational expenditure fell 40% y-o-y to $245.4 million. Staff count, which has fallen to 13,500 from 16,700 a year ago, is set to go lower. “There are cost-saving initiatives which are still ongoing in the second quarter, so you’ll see that number coming down progressively,” he says.
Analysts not optimistic
Despite these efforts, many analysts are not optimistic. Only a strong recovery in air travel will reverse the company’s fortunes ahead and that is not apparent now. The company’s key associates, especially in China and India, also do not have the benefit of the job support scheme, notes UOB Kay Hian.
Moreover, Country Foods had lowered operating margins in Singapore since its consolidation last year, notes analyst K Ajith. Chances are that the unit will only be operating close to breakeven levels in FY2021, it warns. “Even if traffic volumes were to increase, the extent of operating leverage is likely to be limited to just incremental meals, rather than higher flights handled as airlines will be focused on improving load factors,” Ajith writes in an Aug 25 report.
As such, he has downgraded the stock to “sell” and cut his target price to $2.67 from $2.93 previously. He has lowered its FY2021 earnings estimate by $193 million to account for higher losses due to a delay in border openings. He has also lowered his FY2022 earnings forecast by $217 million.
Similarly, Phillip Securities’ Paul Chew has maintained his “sell” rating with an unchanged target price of $1.95. In an Aug 25 note, he warns there is no clarity of a “sustainable and material improvement” in air travel, which is likely to extend the company’s losses ahead. “SATS has likely bottomed out operationally but we worry such listless conditions may persist for another three to four quarters,” writes Chew.
Nevertheless, CGS-CIMB’s Lim Siew Khee has a different view. She has upgraded the stock to “hold” from “reduce” with a higher target price of $3.00 from $2.80 previously, as she believes the worst could be over for SATS because the company will benefit from improving cargo volume and the upcoming peak season from September to December.
Moreover, better freight rates on the back of stronger demand for perishable and medical supplies should bode well for the company, she adds. “[Ebitda] could improve sequentially,” writes Lim in her Aug 25 report.
Shares of SATS are down 41.5% year-to-date to close at $2.96 on Aug 26.
