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Singapore Airport Terminal Services Ltd – Proxy to Tourism & Hospitality boom

Phillip Securities Research Pte Ltd

27 May 2010

Exchange Singapore Stock Exchange Sector Airport Services & Food

Solutions Reuters SIAT.SI Bloomberg SATS SP

(Hold) Initiation Closing Price

S$2.5412-month Target Price

S$2.87 (+13.1%)

Last Price 2.540 52wk High (4/15/2010) 2.92 52wk Low (5/27/2009) 1.48Shares Outstanding (mil) 1092.348Market Cap (S$ mil) 2774.56Avg. Daily Turnover (mil) 6.08Free float (%) 56.12PE (X) 15.21PB (X) 1.87

1M 3M 6MAbsolute -11.2% -2.7% -2.7%Relative -1.0% -0.7% -0.3%

Price performance %

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3.5

5/26/2009 9/26/2009 1/26/2010 5/26/20100

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Major Shareholders % 1. Temasek Holdings Ltd 43.75%

Source: Bloomberg Phillip Securities Research Team

65 65311221 FAX 65 65364435

[email protected] Web: www.poems.com.sg MICA (P) 153/01/2010 Ref No: SG2010_0179

Singapore Airport Terminal Services Ltd (SATS) is a leading provider of Airport Services & Food Solutions. The company is very established in the aviation industry and has a strong presence in Singapore. The company underwent revolutionary changes in recent years and managed to diversify its profit base to non-aviation food services, through the acquisition of Singapore Food Industries and Country Foods. SATS has a relatively strong competitive position, scoring 16.0 out of 25.0 points in our Porter’s 5 Forces ratings (an elaboration of the ratings of individual business segments can be seen in figure 11). Key drivers of growth: • The expected increase in tourism traffic in Singapore would directly benefit the aviation

related business, as air transport is the preferred mode of transport for tourists. • The increase in tourist arrivals would also provide opportunities for the company to grow

its non-aviation food solutions business through catering services during large scale events, such as Youth Olympics Games (YOG) and Formula 1 racing.

• The UK non-aviation food business’s revenue had been growing at a 10% CAGR and we expect the growth trend to sustain for the next few years.

• Airport Services & Food Solutions through associated companies Potential upsides: • The company could have significant upside in earnings due to increase in cargo volumes

from the opening of the perishable cargo warehouse (Coolport@Changi) in mid 2010. • The company could potentially penetrate the European aviation food markets through

Daniels Group. Key risks: • As the Group has a significant exposure to the aviation industry, negative business

environment could adversely affect the company. • With significant businesses overseas, foreign currency movements could impact the

bottom line. • With 67% of the company’s revenue coming from food related business, increase in raw

food prices would affect the profit margins. Valuation: We expect revenue to grow between 4.4% and 10.3% over the next two years, driven primarily by increase in tourist arrivals into Singapore. The valuation methodology that had been employed for SATS was a blended mix of equal proportions to the Free Cash Flow to Equity (FCFE) model, justified P/E model and justified P/B model, with reference to its justified ratios. Our assessment for the stock is a HOLD call with a price target of $2.87.

Conso' Ending

Profits SGD(mill)

EPS SGD ¢

DPS SGD ¢

BV SGD

ROE (%)

P/E (X)

Yield (%)

P/BV (X)

3/08 A 195.2 18.2 14.0 1.29 14.4 12.6 6.1 1.793/09 A 148.5 13.6 10.0 1.30 10.6 8.9 8.3 0.933/10 A 182.1 16.7 13.0 1.36 12.5 15.9 5.1 2.013/11 E 225.7 20.4 15.2 1.42 14.6 12.4 6.0 1.803/12 E 225.4 20.1 15.0 1.47 13.8 12.6 5.9 1.72

Singapore Airport Terminal Services Ltd 27 May 2010

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Company Profile Singapore Airport Terminal Services Ltd (SATS) is a leading provider of Airport Services & Food Solutions. The group’s businesses are located mainly in Singapore, but it also gains geographical exposure through its subsidiaries and associated companies in India, Hong Kong (HK), Macau, China, Taiwan, Australia and United Kingdom (UK). SATS operated as a subsidiary of Singapore Airline (SIA) until September 2009, when SIA divested its interest in SATS through a distribution in specie. Business Segments

Airport Services SATS operates airport services, such as passenger checking-in services, ramp services, baggage handling services, air freight handling services and aviation security, primarily in Singapore’s Changi Airport. They provide services to both full service airlines, as well as Low Cost Carriers (LCC).

Food Solutions- Aviation & non-Aviation SATS has two lines of business in aviation and non-aviation related food solutions. The aviation side of the food business involves airline catering services, including menu planning, inventory control, replenishment of bar carts and amenities to various airlines. The non-aviation side of the food business is held mainly through its subsidiary, Singapore Food Industries (SFI) that was acquired in April 2009. SFI is a fully integrated food logistics and catering supplier to various market segments. SFI also comprise of Daniels Group based in UK, thus giving the company access to the European markets. SATS underwent structural changes over the past 3 years. It managed to diversify its revenue base into non-aviation food business and consequently, contributions from the food solutions segment rose from 48% in FY07/08 to 67% in FY09/10. Fig 1. Revenue by business segments (S$ ’million)

Source: Company, Phillip Securities Research

11.912.914.8495.3

508.2481.9

461.4 541.0 1,031.7

0%10%20%30%40%50%60%70%80%90%

100%

07/08A 08/09A 09/10ACorporate Airport Services Food Solutions

Prior to the acquisition of SFI and Country Food Macau, SATS had a very high dependency on the aviation sector. After the acquisition of these two non-aviation food businesses, the Non-Aviation revenue made up 43.1% of the revenue for the Group in FY09/10. Fig 2. Revenue from Non-Aviation business


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Fig 4. The associated companies

Fig 3. Summary of business segments

Business Segment Airport Services Aviation Food Non-Aviation Food

Revenue contribution* (%) 32% 26% 41%

Market Share

- 80% market share in serving military camps in Singapore. -Signif icant player in UK Orange juice & Fresh Soup retail market.

Key Competitors

- SG: NTUC Foodfare. - UK: Bakkavor, Northern Foods, Wellness.

Source: Company, Phillip Securities Research. *Based on FY0910 f inancial results

- SATS have a market share of approximately 80% in aviation related business in Changi Airport.

- Changi International Airport Services (CIAS)

Singapore Airport Terminal Services (SATS)

Business Summary Geographical Base. SATS derives majority of its revenue from Singapore, but has contributions from overseas subsidiaries, primarily in UK and Hong Kong. After the acquisition of SFI (Apr09) and Menzies Aviation (Hong Kong) Ltd (Oct08), the group managed to diversify its geographical revenue base overseas from 0% in FY07/08 to 27% in FY09/10.

CompanyBusiness segment Classification

Percentage holding Location Remarks

LocalSATS Airport Services Pte Ltd Airport Services Subsidiary 100.0% SGAsia-Pacif ic Star Pte Ltd Airport Services Subsidiary 100.0% SGSATS Security Services Pte Ltd Airport Services Subsidiary 100.0% SGSATS Investments Pte Ltd Airport Services Subsidiary 100.0% SGAerolog Express Pte Ltd Airport Services Subsidiary 70.0% SGSATS Catering Pte Ltd Food Solutions Subsidiary 100.0% SGCountry Foods Pte Ltd Food Solutions Subsidiary 100.0% SGSingapore Food Industries Ltd (SFI) Food Solutions Subsidiary 100.0% SGAero Laundry & Linen Services Pte Ltd Food Solutions Subsidiary 100.0% SGOverseasSATS HK Ltd Airport Services Subsidiary 100.0% HK, PRCSATS (India) Co. Pte Ltd (India) Airport Services Subsidiary 100.0% IndiaAir India SATS Airport Services PteLtd (AISATS) Airport Services Joint Venture 50.0% India Announced in Apr10. PT Jasa Angkasa Semesta Tbk Airport Services Associates 49.8% IndonesiaAsia Airfreight Terminal Co. Ltd Airport Services Associates 49.0% HK, PRC Includes 2 subsidiaries in HK & Guangdong

Beijing Aviation Ground Services Co Ltd Airport Services Associates 40.0% Beijing, PRCIncludes 12 subsidiaries in Beijing, Tianjin,Chongqing, Guiyang, Harbin, Wuhan, Nanchang, Changchun, Hohhot, Tianjin.

Tan Son Nhat Cargo Services Ltd Airport Services Associates 30.0% HCM, Vietnam Ho Chi Minh CityEvergreen Air Cargo Services Corporation Airport Services Associates 25.0% Taipei, Taiw anEvergreen Airline Services Corporation Airport Services Associates 20.0% Taipei, Taiw anCountry Foods Macau Ltd Food Solutions Subsidiary 51.0% Macau, PRC Through SFI. S Daniels PLC Food Solutions Subsidiary 100.0% UK Through SFI. Includes Daniels Chilled Foods & Farmhouse Fare.International Cuisine Ltd Food Solutions Subsidiary 100.0% UK Through SFI. Primary Industries (Qld) Pty Ltd Food Solutions Subsidiary 100.0% QLD, Aust. Through SFI. Queensland. Includes Urangan FisheriesShanghai ST Food Industries Co Ltd Food Solutions Subsidiary 96.0% Shanghai, PRC Through SFI. Servair-SATS Holding Company Pte Ltd Food Solutions Associates 49.0% SG Incorp SG, but business in Macau catering Services (34%)Taj SATS Air Catering Ltd Food Solutions Associates 49.0% India Mumbai, Kolkata, Delhi, Armritsar, Goa, Bangalore, IndiaAviserv Ltd Food Solutions Associates 49.0% Karachi, PakistanBeijing Airport Inflight Kitchen Ltd Food Solutions Associates 40.0% Beijing, PRC Includes Tianjin and Shenyang businessMaldives Inflight Catering Pte Ltd Food Solutions Associates 35.0% Male, MaldivesTaj Madras Flight Kitchen Pvt Ltd Food Solutions Associates 30.0% Chennai, IndiaJilin Zhong Xin Cheng Food Co. Ltd Food Solutions Associates 30.0% Jilin, PRC Through SFI. Announced in May10. MacroAsia Catering Services, Inc Food Solutions Associates 20.0% Manila, PhillipinesEvergreen Sky Catering Corporation Food Solutions Long Term Invest. 15.0% Taipei, Taiw an

Source: Company, Phillip Securities Research (SG-Singapore, HK-Hong Kong, PRC- People's Republic of China, Aust.-Australia, UK-United Kingdom)

Subsidiaries & Investments


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Fig 5. Revenue by geography (S$ ’million)


958.0 982.6 1,118.1

420.879.50.0

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07/08A 08/09A 09/10ASingapore Overseas

Associated companies. A list of the subsidiaries and investments of SATS are shown in Figure 4. The Group’s bottom line has significant contributions from its Associates, with majority of the contributions from the Airport services segment. Geographically, the most significant contributions are from China, Hong Kong and Indonesia. In April and May 2010, SATS announced that it had entered into joint venture agreements to form a ground handling unit in India and an integrated pig farm in China, further growing the list of Associated companies of the Group. Fig 6. Associates PBT by business segments (S$ ’million)

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The Associated companies have contributed positively to the bottom line of the Group, as seen from the higher net profit margin with Associated companies. Fig 7. Effects of Associated companies on the Group financials

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Top down evaluation Industry Analysis Food Industry. Aviation Food. Full service airlines have been providing meals onboard airplanes as part of their services to the customers. As a result, SATS has enjoyed a steady stream of revenue from providing inflight catering services to airlines over the years. However, we anticipate that the demand for inflight catering services could undergo a structural shift. As seen from the graph below, the number of passengers handled and gross meals moved in tandem prior to 2006. After 2006, there was a continuous increase in the


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number of passengers handled, but the number of meals served did not experience the same pace of increase as the number of passengers handled. We attribute this change to the increase in consumer demand for Low Cost Carriers and the opening of the Budget Terminal in Changi Airport in March 2006. Fig 8. Gross Meals, Passengers Handled by SATS

Source: CEIC, Phillip Securities Research

23456789

10

Jun-99 Jun-01 Jun-03 Jun-05 Jun-07 Jun-09

Gross Meals ('million)Passengers Handled ('million)

Non-Aviation Food. The food catering industry is highly competitive in Singapore as there are many choices of caterers for customers. Hence, this business segment has strong customer power over the Group. Even though SFI is the only Abattoir and hog auction in Singapore, the revenue contribution from this business segment is not significant relative to the food preparation, manufacturing, processing and distribution business segments. The Group provides catered meals for majority of the military camps in Singapore. SATS’s overseas non-aviation food presence is mainly through UK’s Daniels Group. Daniels Group is a dominant player in two key business segments of Fresh Soup and Freshly Squeezed Orange Juice, where the group has a 46% and 60% market share in the retail markets. The Group also competes in the ready meals industry in UK, one of the largest consumers for ready meals in Europe. Airport Service Industry. The Airport Service Industry is in the life cycle phase of a growth to matured industry. With Singapore’s Changi Airport having 3 full service terminals and a budget terminal, we believe that there is potential for growth in the Singapore market as the Airports are currently operating at only half its maximum capacity. There are several key drivers that will benefit SATS’s Airport Service segment in Singapore. • Singapore as a Tourism hub. Singapore Tourism Board (STB) target to bring in 17million

visitors per year to Singapore by 2015. This target could be possible with the opening of the two integrated resorts in the first half of 2010 and the recovery of global economies.

Fig 9. Visitor arrivals, Singapore


9,681.26

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17m by 2015?

As shown in the figure below, Air transport remains the preferred mode of transport for visitors to Singapore with approximately 75% of visitors arriving by air. In the last two years, there had been a slight pick up above the 70% mark between 2004 and 2008. This could be attributed to the growth of LCC in the region that provided cheap means of air transport to Singapore. We believe that this trend would likely persist to drive the business of SATS. However, it should be noted that LCC requires much lesser airport services as compared to full service airlines


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Fig 10. Visitor arrivals by Transport mode, Singapore Source: CEIC, Phillip Securities Research

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Air Sea Land

• Cargo handling growth. In August 2009, SATS announced a plan to build Coolport@

Changi – Singapore’s first on-airport perishables handling centre. Coolport is expected to be ready by the middle of 2010. We believe that this would open up a new dimension to the cargo handling business of SATS, as they would offer a unique value proposition to customers. The development of Coolport would benefit airlines and increase cargo volume handled, as the range of goods that can be handled would much wider.

• Integrated ground handling services. In April 2010, SATS announced that they had been

awarded a Technical Ramp license at Changi Airport by Changi Airport Group (CAG). Technical Ramp license would enable SATS to provide services such as marshalling, towing of aircrafts and aircraft exterior cleaning. This would enable SATS to provide a full spectrum of airport services to airline customers. The other two ground handlers, who are dominant players in the Technical Ramp services, are Changi International Airport Service (CIAS) and SIA Engineering Company (SIAEC). We believe that it will take significant time for the build up of customer base and fixed asset investments, before the Technical Ramp License services can contribute significantly to the revenue of SATS.

According to Changi Airport Group, the combined maximum handling capacity across the four terminals is 73million passengers per annum. (Terminal 1: 21million, Terminal 2: 23million, Terminal 3: 22million, Budget Terminal: 7million). This implies that Changi Airport is currently operating at only 51% capacity, based on the 37.2million passengers handled in 2009. Therefore, there is still potential for growth in the local airport ground handling business. We also believe that growth of the Airport Services segment of the business would be driven by overseas expansion through formation of joint ventures and acquisitions. The Group is also likely to be a provider of integrated services in the hospitality and tourism business. For example, the Group announced a recent contract worth $5.5million to provide catering services to athletes in the Youth Olympic Games, an indication that the Group is riding the tourism and hospitality growth in Singapore to grow its non-aviation food business. Porter’s Five Forces & SWOT Analysis Fig 11. Porter’s 5 Forces rating

Business Segment Airport Services Aviation Food Non-Aviation FoodCustomer Pow er 4.5 4.5 2.0 Supplier Pow er 4.0 4.0 4.0 Threat of entry 2.5 4.0 4.0 Threat of substitutes 2.0 3.5 1.5 Rivalry among competitors 4.0 4.0 1.5 Segment rating 17.0 20.0 13.0 Revenue contribution 32% 26% 41%Sales weighted overall rating (max 25.0)Source: Phillip Securities Research. * Ratings: 1 indicates strongest pow er, 5 indicates w eakest pow er against Company

16.0

Porter's 5 Forces rating


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Porter’s Five Forces Analysis: Customer power NAF (2.0): The non-aviation food segment of the business faces intense competition from many competitors. There is very strong customer power to switch between various foods providers. AF (4.5): The aviation food segment in Singapore is dominated by two key players, Changi International Airport Services (CIAS) and SATS. Hence, the competition is healthy and customer power is moderate in this business segment. SATS is a dominant player with around 80% market share. AS (4.5): The airport services segment of the business is subjected to relatively low customer power. Airlines transiting through Changi Airport would require the services of ground handlers to facilitate the baggage deliveries, passengers check in and ramp handling services. Supplier power NAF (4.0) & AF (4.0): With large volumes demanded by SATS’s inflight catering business, suppliers of raw food would need to stay competitive with their prices to retain this key customer. Furthermore, after the acquisition of SFI, SATS managed to acquire an even stronger position against food suppliers by demanding higher volume of raw food. Being a significant player in the UK food business with a healthy market share, we believe that the supplier power against the Daniels Group is also not strong. AS (4.0): SATS is dependant on suppliers for airport technologies, raw materials and manpower. Being a dominant market player in Changi Airport operations, SATS have significant power over suppliers of technologies, such as Zebra Technologies Corporation & UFIS Airport Solutions (UFIS-AS). Threat of entry NAF (4.0): The non-aviation food segment faces lower barriers to entry. However, it will not be easy for new entrants to achieve the economies of scale of SFI, in both Singapore and UK, with many players in the market. AF (4.0): The threat of entry for the food solutions segment is low. The aviation food segment requires good working knowledge of the demands of airline customers and significant capital expenditure to locate strategically near the airports for ease of support. AS (2.5): The threat of entry into the Airport Services segment of the business is relatively high. The decision to add new players into the Changi Airport market is dependant on Changi Airport Group. We see this as a likely threat to the margins that SATS is able to enjoy if competition intensifies. By taking a look at the history of ground handling in Singapore, threat of entry is certainly detrimental to SATS. In 2005, Civil Aviation Authority of Singapore (CAAS) awarded a third ground handling license to Swissport International. From the feedback that CAAS received from airline customers, ground handling charges reduced by 15% since Swissport started operations. This certainly affected the profitability of the other two ground handling units, SATS and CIAS. However, due to the lack of market share, Swissport was not profitable in the unfavorable industry environment and decided to pull out of Changi Airport in


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March 2009. We still see significant threat of entry from a third ground handler, should traffic volumes increase sufficiently in Changi Airport to attract global players into the business. Threat of Substitutes NAF (1.5): The non-aviation food segment faces a myriad of substitutes from various food choices. AF (3.5): For aviation food segment, there is a fairly low threat of substitutes as there are few alternatives to quality prepared meals on airplanes. AS (2.0): There is a moderate threat of substitute for Airport Services. The threat of substitute would come from the scaling down of requirements for passenger and baggage handling services. With technological advancements, the general trend in the airline industry is towards self check-in by passengers. The self check-in process would reduce demand for passenger handling services on the long run, as it is a substitute for SATS’s services. The structural shift towards LCCs would reduce the demand for baggage handling requirements. Hence, the substitute for this business segment would be the work done by customers themselves. The effects of this threat would depend on how SATS transform their business model to keep up with changing times. Rivalry among existing competitors NAF (1.5): However, the non-aviation food segment has very intense competition among existing players, which requires significant expenditure on marketing, selling and distribution expenses for the players to differentiate themselves from others. As seen below, after the consolidation of SFI’s business in the last 2 months of FY08/09, which comprise mainly of non-aviation food, the “other cost” slice of the cost base rose significantly. This is likely due to the increase in cost due to marketing, selling and distribution expenses from that business segment. AS (4.0) & AF (4.0): The airport service and aviation food segment is dominated by SATS and CIAS. We expect the competition to stay healthy in order not to hurt the profitability of both companies. Fig 12. Other Costs (including marketing, selling & distribution)


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SWOT Analysis: Strength – Customer relationships, Financials As an established player in Changi Airport, SATS understand the requirements and operational demands of airline customers. Moreover as a previous subsidiary of SIA, SATS had developed good rapport and understanding of the business demands of the largest airline in Changi Airport. Despite being divested from the SIA Group in Sep 2009, SATS is likely to retain this key customer and currently has a firm contract with SIA till Sep 2012. Responsible for around 80% of the flight traffic at Changi Airport, SATS is a dominant player in airport services for airlines. After repaying its $200million medium term notes in FY09/10, the Group has very little debt on its balance sheet. This would reduce the risk of significant interest costs, associated with any refinancing needs, at higher interest rates expected in the future. The substantial shareholder of more than 50% shareholding is Temasek Holdings Pte Ltd, a Sovereign Wealth Fund (SWF) of Singapore. This substantial shareholder would provide strong financial backing for the Group.


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Fig 13. Flights handled as % of Changi Airport Flight Traffic


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SATS have a good track record of paying out a significant portion of its profits as dividends. As seen from the chart below, apart from the special dividend payout in FY03/04, the dividends yield history had been between 2%-13%. This is a remarkable history considering that the Group managed to acquire SFI in 2009 with internally generated funds, while maintaining its dividend track record. For the past 3 yrs, the dividend payout ratio is between 73.5% and 78.1%. Fig. 14. Dividend yield of SATS

Source: Bloomberg

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Weakness – Dependency on Aviation health SATS’s aviation related business is highly dependant on the health of the overall airline industry. The company might also have difficulty in expanding its business, as the company would likely require mergers and acquisitions in order to grow in the fairly saturated business environment. However, the ability to acquire businesses at a favourable price is highly dependant on market conditions. Opportunities – Daniels Group, Tech Ramp, JV & Associates Leveraging on the acquisition of SFI, SATS would be able to position itself for growth in the UK food industry. According to the company, Daniels group has been growing at 10% Cumulative Average Growth Rate (CAGR) over the past 5 years. We see the opportunity for SATS to use Daniels Group as a platform to break into the aviation food business in Europe.


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Fig. 15. Growth of Daniels Group

Source: Company With the license from CAG to provide from Technical Ramp services, we see the potential for SATS to be a provider of the full range of ground handling services to airline customers. Prior to acquiring this license, SATS would refer Technical Ramp business to SIAEC, a subsidiary of SIA. We believe that in order to quickly build up this segment of the business, acquisition of other players would be the more viable option, as compared to slowly growing its own business from scratch. Several of the Joint Ventures and Associated have yet to contribute significantly to the bottom line of the Group. These associated companies could provide upside potential on the long run, as they are positioned in the fast growing nations, such as India and China. Threats – Third Ground Handler, Change in consumer preference As evaluated in the analysis from the previous section, key threats to SATS are primarily from the entrant of a third ground handling unit into Changi Airport and a structural shift to lower demand for inflight catering, passenger and baggage handling services from customers, with the growing popularity of LCCs. Fig. 16. SWOT summary Strength Weakness• Established player in Ground handling • High dependency on Airline industry • Good working relationships with SIA • Difficulty in expanding business• Large market share in Changi Airport• Low Debts and strong financial backing• Good dividend track recordOpportunities Threats• Potential growth in UK Food and opportunity to break into Europe Aviation Food industry

• Entrant of third ground handler

• Licensed to provide full range of ground handling services to customers

• Structural shift to lower demand for inflight catering, passenger and baggage handling services

Risk Factors Aviation Industry Risk. As the airline industry is cyclical in nature, the aviation sector of SATS’s business had been and will continue to be highly correlated to the health of the airline industry. The rates associated with providing airline services could vary over time, especially when the effects of externalities, such as pressures from airline customers and competition from new entrants, reduce rates charged by SATS and ultimately affecting their revenue. Hence, it is not just the volumes that will affect the revenue of the company. Foreign Exchange Risk. The functional and reporting currency of the company is Singapore dollars (SGD). As discussed in the business summary section, the Group has significantly increased their revenue contribution from outside of Singapore. Hence, the foreign exchange rate risk has increased. The most influential foreign currency on the revenue of the Group


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would be the British Pound (GBP), accounting for 24% of the revenue earned in SGD terms in FY09/10. Counterparty Risk. The counterparty risks for the group is fairly concentrated in the aviation sector, with airlines accounting for almost half of the total financial assets outstanding on 31 March 2009. The next most significant counterparty would be the financial institutions, which accounts for 26% of the financial assets outstanding as of 31 March 2009. An updated risk profiling has not been released by the Group. The risk of default from airlines is particularly significant during recessions, as we have seen from the bankruptcy filings of airlines such as Japan Airline in Jan 2010 and Northwest & Delta Air in Sep 2005. Concentration Risk. The revenue of the Group is highly concentrated in Singapore and particularly on the business of Changi Airport. Hence, factors that affect the business environment of Changi Airport would severely affect the business of SATS. Overall, the revenue contribution from Singapore accounts for 73% of the Group total revenue. Raw Food Prices. The food solutions segment accounts for 67% of the Group’s business by revenue. The cost of sales, due to cost of raw materials, in food business accounts for a significant proportion of the cost base. After the acquisition of SFI, raw material costs accounts for an even larger percentage of Group revenue. The raw materials as a percentage of revenue increased from an average of 9%, between April 2004 and March 2008, to 27% in FY09/10. Fig. 17. Risk assessment

S/N Risk Factors Driver Impact Financial ImpactLikelihood of occurrence

1 Aviation Industry risk Revenue (↓) Moderate High

2 Foreign Exchange riskRevenue (↓)

Cost (↑) Low Neutral3 Counterparty risk - Varies Moderate4 Concentration risk Revenue (↓) Moderate Low5 Raw food price risk Cost (↑) Moderate Moderate

Source: Phillip Securities Research Company Trends & Forecasts Company Trends Prior to April 2009, SATS is highly dependant on the aviation industry for its revenue. After the key acquisition of SFI in April 2009, the Group managed to diversify its revenue base and we see a structural shift in the business strategy and directions. Consequently, there is a significant change when we compare the ratios for the Group. As shown from the figure below, the Total Asset Turnover (TATO) for the Group stayed relatively stable from FY04/05 to FY08/09 at an average of 0.56X. From FY09/10 onwards, we expect the TATO to rise significantly due to the additional of SFI. The higher TATO is likely to stay persistently high for the Group, as SFI had demonstrated a higher average TATO of 1.87X for CY2004-2008. However, we expect profit margins to reduce permanently for the Group as the Food industry traditionally has relatively lower profit margins. The net effect of all these competing factors will likely result in a Return on Equity (ROE) of approximately 13% for the Group. Fig. 18. Key Ratios

Source: Company, Phillip Securities Research5%

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Cost Drivers More than 70% of the Group’s cost base comprise of staff costs and raw material costs. We believe that the ability of the Group to pass on these costs to customers would be the key difference in the profitability of the Group. Fig. 19. Breakdown of Expenses


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Licensing fees

Depreciation and amortisationchargesCompany accommodation andutilitiesOther costs

The Food industry segment of the business is highly competitive. Therefore with many alternatives to the product offerings, we do not expect the Group to be able to pass on majority of any raw material price hikes to their customers. As seen from the chart below, raw material cost has grown to become a significant portion of the cost base as compared to its historical values. Hence, we see raw material price hikes to be a key threat to the gross profit margins of the Group. With majority of the Group’s business located in Singapore, the increase in CPF contribution rate from employers would also affect the Staff cost base of the company significantly. Even though the Staff cost as a percentage of the revenue is lower, the Group reported that it has 11,487 employees as of March 2009, which is a 45% increase over the 7,938 employees reported in March 2008. Fig. 20. Trend of expenses as % of Revenue


44% 44% 47% 45% 42% 35%27%

15%9%9%9%9%

0%

10%

20%

30%

40%

50%

04/05A 05/06A 06/07A 07/08A 08/09A 09/10A

Staff costsCost of raw materials

Valuation Methodology The valuation methodology that had been employed for SATS was a blended mix of equal proportions to the Free Cash Flow to Equity (FCFE) model, justified P/E model and justified P/B model. The justified P/E and P/B ratios are computed using the Gordon’s Growth Model by assuming a terminal growth rate of 2.0%. Financial Evaluation Forecasts Revenue. We expect revenue to grow between 4.4% and 10.3% over the next two years, driven primarily by increase in tourist arrivals into Singapore. The significant increase in revenue between FY08/09 and FY09/10 is due to the incorporation of revenue from SFI into the SATS Group revenue. Within our estimates, we are also factoring in a 6.0% increase in the revenue from the SFI Group primarily due to expectations of improving revenue figures from


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UK’s food business from Daniels Group and contract wins in non-aviation food segments. In our estimates, we assumed that there is no significant change in exchange rate between SGD-GBP. Ratios & Profits. As explained in our discussion of the company trend, we expect the profit margins of the Group to reduce to the range of 12%-13% and return on equity (ROE) to stay within the range of 13-14% over the next two years. The growth in the non-aviation food segment and how well the Group can innovate to ensure stickiness of its clients would be critical to the sustainability of the profits. Dividend. SATS have maintained a healthy dividend pay out of 73.5-78.1% over the past three years. Even with that high payout ratio, the Group managed to finance the significant acquisition of the SFI Group. This is an indication of the high cash generating ability of the Group, primarily driven by low CAPEX requirements of the established business. As significant amount of the fixed assets had been depreciated, there is low depreciating expense on the income statements. By assuming a dividend payout ratio of 75%, investors interested in the dividend yield can look forward to dividend pay out of approximately 15cents in FY10/11 and FY11/12. Fig. 21. Financial Forecasts

07/08A 08/09A 09/10A 10/11E 11/12ERevenue (S$ 'million) 958.04 1,062.09 1,538.90 1,696.34 1,772.36 Profits (S$ 'million) 195.18 148.46 182.10 225.72 225.36 Dividends (cents) 14.00 10.00 13.00 15.21 14.99 ROE (%) 14.43% 10.59% 12.49% 14.63% 13.84%ROA (%) 10.68% 7.61% 9.20% 11.47% 10.86%Net Profit Margin (%) 20.37% 13.98% 11.83% 13.31% 12.72%Source: Phillip Securities Research

The stock price of SATS had been on a gradual uptrend from 2000 to 2006. But showed a steep decline before rebounding along with the broad market recovery in early 2009. Fig. 22. Stock Price

Source: Bloomberg, Phillip Securities Research0

0.51

1.52

2.53

3.54

May-01

May-02

May-03

May-04

May-05

May-06

May-07

May-08

May-09

May-10

Even though the earnings for the company were reduced significantly during the recession in 2008, valuations depressed even further as the stock price was dipped along with general risk aversion in the stock markets. The average multiples for the stock over the past 5 years are at 1.85X and 13.68X for P/B and P/E respectively. The stock is currently trading are at approximately mid cycle valuations. Fig. 23. Historical Valuations

Source: Bloomberg, Phillip Securities Research0

5

10

15

20

25

30

May-05 May-06 May-07 May-08 May-09 May-100

0.5

1

1.5

2

2.5

3P/E (X), LHSP/B (X), RHS

When we compare the valuations based on Net Tangible Assets (NTA) instead of book value,


14

it is important to note that the stock is currently trading at a relatively high Price to its NTA. This is due to more than S$461million of intangible assets on the balance sheet after the acquisition of SFI. This large amount of intangible assets is due to significant amount of goodwill (S$241million) added to its book, as SATS paid a premium for business of SFI. There is also a significant amount of intangibles on the balance sheet of SFI, including Brands, Customer relationships and Licenses, subsequently added to SATS’s balance sheet. This significantly higher valuation is likely due to market expectations of higher growth rate to the Group due to expansions in recent years. Fig. 24. NTA, P/NTA

Source: Phillip Securities Research

1.0

1.2

1.4

1.6

1.8

2.0

04/05A 05/06A 06/07A 07/08A 08/09A 09/10A0.0

0.5

1.0

1.5

2.0

2.5NTA per share, S$ (LHS)Price/NTA, X (RHS)

We shall conclude our valuation discussion with our blended price target for this SATS. We assumed a base case scenario with a terminal growth rate of 2.0% for the stock. We gave equal weights to Justified P/E, Justified P/B and FCFE models. The Justified P/E and Justified P/B are calculated with reference to the Gordon’s Growth model. The FCFE model is calculated based on parameters below. Fig. 26. FCFE Valuation ParametersRisk free rate, Rf 2.61%Beta 0.597Expected Market Return (Rm) 11.00%Market Risk Premium (Rm-Rf) 8.39%Cost of Equity Re = Rf + β(Rm – Rf) 7.62%Terminal growth rate (g) 2.00%Equity Value (S$ ‘millions) $4,226.85 Number of Shares ('millions) 1,093.15Fair Value per share (SGD) $3.87 Source: Phillip Securities Research

The Blended target price is achieved based on the parameters below. Key inputs to our valuation model are the Expected market return (Rm) & Terminal growth rate (g). We will stress these two critical inputs in our sensitivity analysis below. Fig. 27. Blended Valuation

Justified P/E

Justified P/B

FCFE Valuation

Blended Valuation

Multiple (X) 13.61 1.82 - -Valuation per share (SGD) $2.27 $2.46 $3.87 $2.87

Sensitivity Analysis The base case scenario for the terminal growth rates would be 2% for Terminal growth rate and 11.0% for the Expected market return. We will stress the parameters by 1.0% increment and decrement. By stressing the parameters, we obtained a price range of $2.27-$3.95.


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Fig. 28. Sensitivity Analysis

3.0% 2.5% 2.0% 1.5% 1.0%12.0% 3.05 2.80 2.60 2.42 2.2711.5% 3.23 2.96 2.72 2.53 2.3611.0% 3.44 3.13 2.87 2.65 2.4710.5% 3.68 3.13 3.03 2.79 2.5810.0% 3.95 3.53 3.20 2.93 2.71

Source: Phillip Securities Research

Terminal growth rate (%)

Expected Market return

(%)

Peer Comparison Aviation Services The closest peer to SATS would be Changi International Airport Services Pte Ltd (CIAS) – a wholly owned subsidiary of DNATA, part of the Emirates Group. SATS and CIAS dominate the ground handling and aviation food market in Changi Airport with market shares of 80% and 20% respectively. CIAS was previously owned by Temasek Holdings, but was divested in 2004 to increase competitiveness in the local ground handling market. The services provided by the two companies are very similar and they compete in a duopolistic environment in Changi Airport. However, the financials of CIAS are not publicly available as it is a privately held entity. A comparison with the parent entity, Emirates Group would not be meaningful as there are many holdings in Emirates Group which are in different business from SATS. Hence, a group of listed peers from various regional airports are selected for comparison with SATS. The average multiples of the Airport Services peers shows a P/E of over 31X, which is much higher than that of SATS. The average P/B is lower than that of SATS at 1.3X. Fig. 29. Peer comparison Airport Services Peers

Name

Last done (SGD)

Mkt Cap (SGD mill)

EPS SGD ¢

P/E (X)

P/B (X)

ROE (%)

Debt/Equity (%)

MALAYSIA AIRPORTS HLDGS BHD 4.90 2,285.1 0.14 14.71 1.65 11.52 20.98JAPAN AIRPORT TERMINAL CO 1,261 1,659.5 0.46 44.65 1.06 2.33 55.94AUCKLAND INTL AIRPORT LTD 1.83 2,263.9 0.03 28.34 1.32 4.65 57.09BEIJING CAPITAL INTL AIRPO-H 3.83 2,991.3 0.01 54.68 1.30 2.41 170.28SHANGHAI INTERNATIONAL AIR-A 13.79 5,471.9 0.08 31.20 2.03 6.73 24.58AIRPORTS OF THAILAND PCL 32.00 1,976.9 0.02 15.77 0.68 4.31 86.80Average 31.56 1.34 5.33 69.28SINGAPORE AIRPORT TERMINAL S 2.54 2,774.6 0.17 16.59 2.04 12.58 1.61Source: Bloomberg, Phillip Securities Research Non-Aviation Food Services In the non-aviation food segment, SATS’s UK business competes with many players in the food industry. Hence, a group of listed peers from UK are selected for comparison with SATS. The average multiples of the Food Services peers shows a P/E of 11X, which is slightly lower than that of SATS. The average P/B is higher than that of SATS at 2.7X. Fig. 30. Peer comparison Food Services Peers

Name

Last done (SGD)

Mkt Cap (SGD mill)

EPS SGD ¢

P/E (X)

P/B (X)

ROE (%)

Debt/Equity (%)

ASSOCIATED BRITISH FOODS PLC 926.00 14,868.8 1.05 16.61 1.53 9.72 27.28CRANSWICK PLC 816.50 783.9 1.01 13.71 2.17 16.83 38.18NORTHERN FOODS PLC 45.00 427.8 0.01 7.55 5.34 37.49 506.72DAIRY CREST GROUP PLC 366.00 989.3 1.40 5.13 1.79 32.43 152.31Average 10.75 2.71 24.12 181.12SINGAPORE AIRPORT TERMINAL S 2.54 2,774.6 0.17 16.59 2.04 12.58 1.61Source: Bloomberg, Phillip Securities Research


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Conclusion We believe that the key driver of growth for SATS would be the expected increase in tourism traffic in Singapore. The ability of the Group to position itself to be a provider of integrated solutions for the tourism and hospitality industry would be the key to the success of the company. Potential upsides could be from increases in cargo volumes due to the opening of the perishable cargo warehouse in mid 2010 and penetration of the European food and aviation markets through Daniels Group.


17

Financials Income Statement for FY ending 31 March (SGD 'million)

2008A 2009A 2010A 2011E 2012E Balance Sheet for FY ending 31 March (SGD 'million)

2008A 2009A 2010A 2011E 2012E

Revenue 958.04 1,062.09 1,538.90 1,696.34 1,772.36 PPE 564.83 608.38 594.40 602.24 605.31

Staff costs (426.69) (442.76) (545.40) (601.01) (640.56) Investment properties 0.00 7.00 6.50 6.50 6.50

Cost of raw materials (86.47) (155.43) (409.50) (455.91) (481.10) Long term investments 7.89 7.90 7.90 7.90 7.90

Licensing fees (61.85) (59.89) (56.80) (56.80) (56.80) Joint ventures 0.00 0.27 0.00 0.00 0.00 Depreciation and amortisation h

(59.18) (64.59) (90.80) (82.10) (87.07) Associates 333.31 333.47 334.80 370.01 398.32 Company accommodation and tiliti

(69.72) (77.09) (90.80) (100.09) (104.58) Intangibles 7.54 475.00 461.90 434.96 407.83

Other costs (79.76) (91.45) (161.20) (177.69) (185.66) Other non-current assets 9.45 18.00 17.90 17.90 17.90

Operating Profit 174.37 170.89 184.40 222.75 216.60 Total non-current assets 923.01 1,450.01 1,423.40 1,439.52 1,443.75

Interest on borrow ings (6.14) (6.71) (5.30) (0.53) (0.58) Accounts receivables 164.00 231.82 236.00 279.38 291.90Interest income 15.72 6.87 0.60 0.98 1.70 Deposits w ith related company 79.50 140.27 0.00 0.00 0.00Dividend from long term investment 1.12 1.17 0.00 0.74 0.74 Inventories 13.89 56.62 43.10 69.75 73.61Share of profits of associates 44.71 22.23 41.90 48.01 53.06 Fixed deposits & Cash 620.83 137.28 196.40 226.96 305.96Share of profit/ (loss) of JV 0.00 (0.00) 0.00 0.00 0.00 Other current assets 48.33 34.39 10.20 10.20 10.20

Total current assets 926.54 600.37 485.70 586.29 681.67Profit before tax 248.78 183.52 223.00 271.95 271.52 Taxation (53.60) (35.06) (40.90) (46.23) (46.16) Total Assets 1,849.55 2,050.38 1,909.10 2,025.81 2,125.42Profit after tax 195.18 148.46 182.10 225.72 225.36

Accounts payables 126.82 204.30 219.30 250.59 264.49

Equity holders of the company 194.91 146.78 181.20 224.60 224.25 Provision for taxation 56.12 53.86 43.90 43.90 43.90Minority interest 0.27 1.68 0.90 1.12 1.11 Other current liabilities 0.82 234.64 14.10 14.10 14.10

Total current liabilities 183.75 492.80 277.30 308.59 322.49 Growth and Margins (%) 2008A 2009A 2010A 2011E 2012ESales grow th 1.31% 10.86% 44.89% 10.23% 4.48% Net current assets 742.79 107.57 208.40 277.70 359.18 EBIT grow th 5.15% -19.93% 20.02% 19.35% -0.14%

EBITDA grow th 1.76% -14.13% 25.23% 11.12% 1.30% Notes payable 200.00 0.00 0.00 0.00 0.00

Net Income grow th 9.05% -23.94% 22.66% 23.95% -0.16% Other non-current liabilities 77.90 141.24 131.70 131.70 131.70

Total-non-current liabilities 277.90 141.24 131.70 131.70 131.70 EBIT margin 24.80% 17.91% 14.84% 16.06% 15.35%

EBITDA margin 30.98% 23.99% 20.74% 20.90% 20.26% Total Liabilities 461.65 634.03 409.00 440.29 454.19Net Profit Margin 20.37% 13.98% 11.83% 13.31% 12.72%

Share capital 250.08 255.18 288.00 291.74 295.54

Cashflow (SGD 'million) 2008A 2009A 2010A 2011E 2012E Reserves 1,133.83 1,142.89 1,193.80 1,275.20 1,356.83

Prof it before tax 248.78 183.52 223.00 271.95 271.52 Total Equity to equity holders 1,383.91 1,398.07 1,481.80 1,566.94 1,652.37 Ops prof it b4 WC change 241.83 237.18 279.80 304.84 303.67

Cash gen. from operations 200.02 237.70 304.00 266.10 301.19 Minority interests 4.00 18.28 18.30 18.58 18.86

Interest paid (6.14) (6.71) (5.30) (0.53) (0.58) Total Equity 1,387.90 1,416.35 1,500.10 1,585.52 1,671.23Income taxes paid (38.71) (47.45) (44.50) (46.23) (46.16)

Cash flow from Ops 155.17 183.54 254.20 219.34 254.46 Key Ratios 2008A 2009A 2010A 2011E 2012EROE (%) 14.4% 10.6% 12.5% 14.6% 13.8%

CAPEX (15.08) (28.08) (64.10) (63.00) (63.00) ROA (%) 10.7% 7.6% 9.2% 11.5% 10.9%

Dividends from associates 15.59 18.31 24.40 22.40 24.75 Current Ratio (X) 5.0 1.2 1.8 1.9 2.1

Dividend from LT investment 1.12 1.17 0.00 0.74 0.74

Interest received from cash 16.18 7.03 0.80 0.98 1.70 Receivable turnover (days) 60.7 68.0 55.5 60.1 60.1

Cash flow from Investment 77.18 (442.34) (14.70) (48.48) (35.81) Inventory turnover (days) 55.0 82.8 44.4 55.8 55.8

Trade payables cycles (days) 71.3 73.1 61.2 65.7 65.7

Dividends paid (139.99) (151.09) (118.90) (169.29) (169.02)

Proceeds from shares option 30.63 0.69 28.00 28.99 29.37 Valuation 2008A 2009A 2010A 2011E 2012E

Cash flow from financing (109.01) (166.75) (318.10) (140.30) (139.65)TTM P/E (X) 12.6 8.9 15.9 12.4 12.6

Net Cash Inflow/(Outflow) 123.35 (425.55) (78.60) 30.56 79.00 P/B (X) 1.8 0.9 2.0 1.8 1.7

Cash & Cash eq, Begin 577.45 700.32 275.70 195.80 226.36

Effects of forex changes (0.48) 0.96 (1.30) 0.00 0.00

Cash & Cash eq, End 700.32 275.74 195.80 226.36 305.36

Source: Phillip Securities Research Pte Ltd


18

Ratings History Singapore Airport Terminal Services Ltd

Rating Date Closing price (S$)

Fair value (S$) Remarks

Hold 27 May 2010 2.54 2.87 Initiation

TRADING BUY Share price may exceed 10% on the upside over the next 3

months, however longer-term outlook remains uncertain BUY >15% upside from the current price HOLD -10% to 15% from the current price

SELL >10% downside from the current price TRADING SELL

Share price may exceed 10% on the downside over the next 3 months, however longer-term outlook remains uncertain

Phillip Research Stock Selection

Systems We do not base our recommendations entirely on the above quantitative return bands. We consider qualitative factors like (but not limited to) a stock's risk reward profile, market sentiment, recent rate of share price appreciation, presence or absence of stock price catalysts, and speculative undertones surrounding the stock, before making our final recommendation

19

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20

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Singapore Airport Terminal Services Ltd – Proxy to Tourism ...internetfileserver.phillip.com.sg/POEMS/Stocks/... · Singapore Airport Terminal Services Ltd 27 May 2010 4 Fig 5