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Changi Airport at a Standstill: Estimating SATS' cash burn (SGX:S58)


SATS’ (SGX:S58) share price has been battered by the COVID-19 situation, with a year to date decline of 44% as of yesterday’s closing.

As some of you may have read, I bought SATS at $4.49 earlier in February. I had been following SATS for a long time, and really liked how the company operates and its growth prospects. At that point of time in early Feb, the Covid-19 situation wasn’t expected to spread so rapidly, hence I felt that the dip in price was an opportunity to accumulate. Subsequently, pandemic spread across the globe, resulting in almost all passenger flights at Changi Airport being grounded. With each new travel ban announced, SATS’ share price continued to take a beating, as their main revenue streams were cut off.
Evidently, the aviation industry has been battered by the shutdown of airports and grounding of flights. US airlines have been negotiating bailout packages with the government, while closer to home, SIA has recently announced a rights issue and a convertible bond offering, to shore up its balance sheet during this challenging time. SIA expects to raise a total of S$8.8 billion, a huge sum which would allow it to withstand these unprecedented times.

With the Covid-19 situation still uncertain and travel bans still expected to be in place at least for the next couple of months, I wanted to look at how SATS’ cash flows would fare in this environment. Specifically, I wanted to estimate how many months of cash burn would SATS be able to withstand before their cash pile is depleted. I was inspired to write this post, after reading Brian’s post on ForeverFinancialFreedom, where he wrote about the cash burn of Singapore Airlines (SIA). I have included the link to his blog here, if you are keen to read further:

Please note that the following estimations are for informational and learning purposes only, and should not be taken as financial advice regarding SATS' shares. All figures and estimations used in the following discussion are for informational purposes, and should not be taken as a solicitation to transact in SATS' shares. When in doubt, please approach a registered financial advisor for advice.

Firstly, I used SATS’ income statement from FY2019, and used the annual figures to calculate a monthly breakdown of revenue and expenses. The key assumption here is that revenue and expenses are evenly split across the months, whereas in reality, air travel tends to peak during the school holidays and during the year end period.

Source: SATS Annual Reports, Author's estimates


Revenue

SATS’ latest annual report, aviation services made up 85.7% of revenue. While passenger travel has fell sharply since the travel restrictions were imposed, cargo flights have declined by a lesser degree, as seen from the Air Statistics that Changi Airport reports monthly. Data from Changi Airport’s website showed that passenger movements fell 32.8% in February 2020, from a year earlier. Whereas for commercial aircraft movements, it was down 12.3% for the same period. Hence for February, I estimated that revenue would have declined by 33%. For March 2020 onward, after the complete ban of all short term visitors to Singapore, air travel is almost non existent, apart from the few flights bringing Singaporeans home. SIA indicated that it has grounded 96% of its fleet.

Non aviation revenue accounted for 14.3% of revenue. While non aviation revenue would also be affected as SATS serves cruise ships as well, their food solutions revenue for non-aviation segment may be less affected. For example, SFI provides catering services which may be less affected by the restrictions. Additionally, SATS also operates central kitchens which may still be operating, given that more packed food is required for takeaways.

Hence, for March 2020 onward, I estimated that revenue would fall 90%, with the remaining 10% revenue representing non-aviation services and the air freight side of aviation operations.

Staff costs

For the February figure, I estimated a 10% decrease in salary expenses, as the first round of pay cuts were introduced in mid-Feb, which reduced the salary of management personnel, allowed staff to go on voluntary unpaid leave or opt for early retirement. In March, SATS announced another round of pay cuts, which included the board of directors, senior managers, managers and assistant vice presidents.

Additionally, the Supplementary Budget announced by DPM Heng included the Jobs Support Scheme, where the Government will offset 75% of ground handling and airport operator’s salaries, capped at $4,600. This would help SATS relieve a huge part of their costs pressures while protecting jobs. As the average staff cost per employee is $52,304 as per their 2019 Annual Report, it would be reasonable to expect that the JSS would cover a significant number of employees, as most of these staff would have salaries below $4,600. Hence, I estimated a 50% decrease in overall salary expenses.

Raw material costs

This is most likely to be variable in nature, given that SATS prepares in-flight meals based on demand. Hence, it is likely that SATS would be able to reduce their raw material costs in proportion to the decrease in revenue. For raw material costs, I pegged it to a % of revenue, and increased it to 20% of revenue from c.14%, to account for the fact that certain raw materials are perishables, which would have to be written off if unused.

License fees

This part gets slightly tricky, as SATS has operations both in Singapore and subsidiaries abroad. For Changi Airport, I think it is fair to estimate that the bulk of the license fees would be waived, as mentioned in the Supplementary budget. To quote from DPM Heng’s Budget speech, “$350 million enhanced aviation support package to fund measures such as rebates on landing and parking charges, and rental relief for airlines, ground handlers, and cargo agents.” Hence, I estimated that 75% of license fees would be waived.

Depreciation and amortisation

I have kept this constant based on the past year’s figures. Depreciation and amortisation are non-cash expenses which would only affect operating profits but not cash flows. Hence, while depreciation remains constant, SATS’ cash flows would not be affected by these figures. Subsequently, I added depreciation expenses back when estimating the cash flows.

Company premise and utilities expense

For utilities, there is both a fixed and variable component as the company would still have to maintain a certain level of operations, which would incur utility costs. Hence, I estimated that company premise and utilities expenses would be cut by 60%. As per the enhanced aviation support package discussed above, rental relief would also be provided to ground handlers, although the actual amount is not specified. This would reduce company premise expense (rental) as well.

Other costs

There’s quite a bit of ambiguity here again, as SATS only mentioned in their Annual Report that “Other costs increased due to higher fuel costs and IT expenses as we continue to invest in technological initiatives to improve service and productivity. Other costs rose to support increased project activities. In particular, professional services costs increased, mitigated by foreign exchange gains and grants received during the year.” Hence, SATS may undertake certain costs cutting measures and scale down on new projects. I estimated that other costs would decrease by 20%.

Interest expense

SATS interest expense has been very low due to its low debt. Recently, SATS raised 200m of debt at 2.88%, which seems like a very favourable rate in this environment. This probably reflects SATS’ strong balance sheet positions with very low debt (gearing ratio of 6%), which allows it to borrow more during this period without significantly affecting its financial position.

Share of results of associates/joint ventures, net of tax

I did not discuss this figure, which amounted to $58 million in FY2019 and $71 million in FY2018. I believe that it is difficult to meaningfully estimate the impact on associates/JVs as this would require a similar level of line by line analysis for each of the associates/JVs. Hence, it is implied that there’s a zero contribution from the associates/JVs during this period, although it is possible that profit contributions from them could be negative if they were to make losses. That would further worsen SATS’ cash burn.

Conclusion

As at 31 Dec 2019, SATS had 212.4 million in cash. In addition to the 200m raised last week, SATS appears to be able to withstand the cash burn over the next few months. During this period, I have taken profit and cut losses on other positions, but SATS is one that I intend to hold for the long term. If you’re keen to learn more about how SATS earns its revenue (during normal times), do check out my earlier post here:  

Lastly, do note that SATS’ largest shareholder is Temasek Holdings, with an approximately 40% stake. If things do deteriorate further, would we potentially see Temasek step in, similar to the situation for SIA? Only time will tell.

Note: As of time of writing, I hold shares in SATS

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How Do We Analyse REITs - A detailed look at factors driving a REIT's value




Real Estate Investment Trusts (REITs) are highly favoured by investors here due to the steady stream of dividends paid out to shareholders. For the good part of the last decade, investors have viewed REITs as quasi-bond instruments, paying out a steady stream of dividends on a quarterly or semi-annual basis. Without much volatility for REITs throughout the last decade, except for the Eurozone debt crisis in 2011, the Fed’s Taper Tantrum in 2013 and the oil price crash in 2015, REITs have rewarded investors fairly well during this period, with a good number of REITs outperforming the Straits Times Index on a total return basis.

‘This time it’s different’ is an extremely dangerous phrase to use in the financial markets; an exceptional run up in prices over 2019 had pushed REIT prices sky high, and as recently as a few months back, some investors were seeing 3-4% yields from REITs as a ‘new normal’, fueled by low interest rates and an insatiable hunt for yield. So much so that some investors have taken this lack of volatility for granted, building up leveraged positions on REITs in order to extract higher income. Bear in mind that REITs are already leveraged vehicles themselves, usually around a 40% debt, 60% equity structure, hence, if one were to further leverage their position on a REIT, that would result in a double leveraged position for the investor. Resulting in one big fat margin call when prices crash. 

Given the keen interest on REITs among retail investors, especially with the sharp selloff over the past three weeks, I decided to write in greater detail about how I look at REITs.

The reason I picked LendLease Global Commercial Reit for this case study was simply because they only have two properties currently (313 Somerset and an office complex in Milan), hence it would be much easier to project the rental revenue with just two properties. Please note that I learnt these valuation methods on my own by reading books or from online sources, mostly before entering university (I’d say 90% of the concepts). Doing these valuation case studies in university probably only trained me to be more cognizant of the formatting, such as colour coding certain figures etc, because these would be relevant if you’re looking to pursue a career in buyside roles or investment banking. Thus, if I overlooked any areas, I’ll apologise in advance and please do point them out to me. 

Please note that the following case study is for informational and learning purposes only, and should not be taken as financial advice regarding LendLease REIT’s shares. All figures and estimations used in the following case study are for illustration purposes only is not a solicitation to transact in LendLease REIT’s shares. When in doubt, please approach a registered financial advisor for advice.

Let’s now take an in-depth look into a REIT’s financial statements:

Revenue Drivers

Firstly, a REIT’s current revenue is determined by these main factors:

1. The rental rates per square feet – usually expressed as per square foot per month (psf/month)

2. The total Net Lettable Area of the property (NLA) – usually expressed in square feet

3. The occupancy rate of the properties – as a percentage of the total NLA

The REIT’s rental revenue for each property can then be calculated by multiplying these three figures, on an annualised basis.

A REIT’s future revenue would mainly be driven by rental reversions, which may be positive or negative. Alternatively, the REIT may undertake acquisitions or asset enhancement initiatives (AEI) to increase their NLA, rental rates and/or occupancy rates. These would form the projections for the REIT’s future rental revenue.


In this example, LendLease’s Milan property has a 12+12 year lease with annual rental escalations tied to the ISTAT CPI growth rate in Italy. Hence, I used a 1% growth rate for projecting the annual rental growth rate. For 313 Somerset, due to the recent COVID-19 situation, I projected that rental rates would fall by 20% in 2020 before recovering in 2021. Do note that a 20% fall is an extremely bearish scenario, as typically a REIT would not renew all its leases in a single year. Hence, assuming a REIT renews 20% of its leases at a 20% decline in rental rates, the overall impact on the rental revenue would only be a 4% decline. However, I used a -20% figure just to get a sense of the impact of an extreme scenario.

Profit and Loss Statement

Once we have projected the REITs rental revenues, the next step would be to estimate the expenses that the properties and the REIT manager incurs.



Net Operating Income (NOI)

In real estate, net operating income is a key metric used to evaluate and value properties. NOI is calculated by deducting all property expenses from rental revenue. NOI margin is expressed as a percentage of total rental revenue. As seen from the financial projections above, the Milan Property has a much higher NOI margin than 313 Somerset. This is mainly because the Milan property is on a triple net lease, which means that the tenant pays for most of the property operating expenses.

Capitalisation Rates

Following on from the NOI discussed above, capitalisation (cap) rates are used to value properties, and cap rates can be compared across similar properties. Think of cap rates as being similar to earnings yield, which is the inverse of the price-to-earnings (P/E) ratio. Basically, when comparing two properties, the property with the lower cap rate means that it has a steeper valuation, assuming that they both have the same NOI. A caveat here would be that we should not simply take the cap rates of similar properties and apply it to the property we’re valuing, as in the case of leasehold properties, this method would not account for the remaining land lease tenure of each property.

For example, a property with a remaining lease tenure of 50 years, generating an NOI of 1mil, valued using a 5% cap rate would give a 20mil valuation. But if we have an adjacent property that also generates an NOI of 1mil but with a remaining lease tenure of 10 years, surely we won’t value that property at a 5% cap as well, and the cap rate used would have to be much higher to account for the extremely short lease tenure left.

In this case study, LendLease’s external valuers valued 313 Somerset at 4.25/4.50% cap rates. For a comparison, CapitaMall Trust’s Plaza Singapura is valued at a 4.50% cap rate. The reason I picked Plaza Sing for comparison is because both malls are in the Orchard Road area, and both malls sit above an MRT station, which gives them a premium. As 313 has a 99 year leasehold tenure commencing in 2006, while Plaza Sing is on a freehold tenure, taking into account the long lease tenure left, the variation isn’t that huge, and the cap rates for both properties might be said to be comparable, the slightly lower cap rate for 313 might be due to 313 being a much newer mall than Plaza Singapura.

Managers fees

This component is usually overlooked when investors discuss about REITs, but should be an important factor to consider as well. This Straits Times article has compared the manager’s fee structures of the various REITs here.


For LendLease REIT, the main recurring management fees are as follows:

1. Management fee of 0.3% of per annum of the value of Lendlease Global REIT’s Deposited Property

2. Performance fee of 5% of NPI

3. Trustee’s Fee of of up to 0.015% per annum of the value of the Deposited Property

The main reason for discussing manager’s fees would be the alignment of interest with shareholders. When the manager owns a stake in the REIT, it aligns their interest with shareholders as they are incentivised to see the REIT perform well. Managers usually take fees in the form of cash and shares, in this case, LendLease’s manager has elected to take 100% of the fees in shares for the first 2 years. However, managers taking fees in shares would also dilute existing shareholders, hence it is imperative that there is also DPU growth to offset the dilution effect. Here there’s a trade off between dilution and the alignment of interest.

Debt, Interest expense and Interest Coverage Ratio

Debt financing forms a huge part of a REIT’s capital structure – and has to be delicately managed. Too little debt, and it means that shareholders are not maximizing their income as more debt can be deployed to acquire more properties, in order to generate higher rental income. Too much debt, and the issue of servicing the debt and meeting regulatory requirements arises. Singapore REITs have a 45% gearing limit, which means that total debt cannot exceed 45% of the REIT’s total assets. There has been discussions about raising this 45% limit by MAS, but nothing is confirmed at this point. The issue of high leverage increases the risk of exceeding the 45% gearing limit if property prices were to crash, which was what happened during the Global Financial Crisis of 08/09. REITs would then have to turn to rights issues to raise capital. I have written an article on this as well. REITs during GFC.


Interest expense here is calculated simply using the weighted average cost of debt multiplied by the total amount of outstanding debt. This is certainly a rough estimate of the interest expense, but if you’d want to be more specific, you may want to look at the individual financing sources and their specific interest rates. Regardless, REITs would ideally want to keep their funding costs low, as this means more income available for distribution to shareholders. On this point, most REITs would also hedge their interest rate exposure, mainly through swaps to ensure that they would not be affected by rising rates in the near future. Conversely, given the current direction which interest rates are heading, the lower rates means that REITs which have swapped their debt for fixed rates would benefit little from this trend.

The interest coverage ratio (ICR) measures how many times of interest expense can be covered by the REIT’s profits before interest and tax. In times like these, rental revenue is uncertain as some tenants may default, and a higher ICR is better as it gives the REIT a greater buffer in challenging times. LendLease has an extremely high ICR of 10.8x, mainly due to its low borrowing costs.

Outstanding shares

This is linked with the earlier section about management fees paid in units, as paying mangers in the form of units would enlarge the number of shares outstanding. This would dilute the existing shareholders, but ideally, rental growth is able to keep pace with the increase in number of shares to ensure that distributable income per share continues to grow.

Valuation – Dividend Discount Model



In a dividend discount model (DDM), we are basically valuing the future dividends that a REIT distributes and discounting them to their present value. I’d like to say that personally, I’m not exactly a fan of using a DDM, as the valuation is extremely subjective and sensitive to the inputs. For example, using a terminal growth rate of 1% or 2% makes a huge difference to the implied valuation. However, this method is still widely used in the industry, and to be honest, what’s a viable alternative?


In this case study, I simply used a discount rate of 7.5% to 8.0%, and a terminal growth rate of 1.5%. One might also choose to use an exit cap rate method to obtain the terminal value, but I feel that method is slightly more difficult to appreciate and hence would not be elaborating on that here.

Additional factors beyond the financial statements

Lastly, there are additional qualitative and macro factors that might affect the valuation of the REIT.

1. Sponsor strength: REITs with reputable sponsors generally enjoy more stability, as the financial strength of their sponsors may give investors some assurance during challenging times. It is also important to look at the REIT’s pipeline of their right of first refusal (ROFR) properties. Basically, a ROFR clause means that if the sponsor wants to sell one of their properties, it would first have to offer the REIT the opportunity to purchase the property on a willing buyer, willing seller basis.

2. Macro factors: Is the REIT’s assets mainly in Australia? Or the UK? Or Europe? This would expose investors to FX volatility. You might want to take a view as to whether these economies would do well in the near future.

I hope this article has been informative, and do share it with someone who you think would find this useful as well!


Note: As of time of writing, I do not hold a position in LendLease Global Commercial REIT

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Please note that these articles are for discussion and informational purposes only and should not be relied upon as financial advice. Readers should consult their licensed financial advisers before making investment decisions. Please read the full disclaimer available on the desktop version of my blog.