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The articles in the blog are intended for informational purposes only, with the aim of encouraging thoughtful discussions. The articles should not be relied upon as financial advice. Please read the important disclaimer at the bottom of the page before proceeding.

Thoughts on SATS' 1Q results




SATS released their 1Q FY2021 business updates on 24 August, which was for the period of 1 April 2020 to 30 June 2020. Headline numbers were a 55% fall in revenue to $209.4m, and a net loss of $43.7m. Aviation revenue decreased 72.9% to 110.6m while non aviation revenue rose by 73.3% to 96.9m.

Despite the challenging operating environment, I believe that the long term outlook for the aviation industry is still positive. In short, as the middle class gets wealthier, demand for air travel should increase as well. I believe that this is a long term secular trend that has only been temporarily disrupted by Covid. While Covid has probably resulted in many executives re-thinking the necessity for business travel, I believe that leisure travel would still recover strongly due to all the pent up demand. Even if business travel were to never recover to pre-Covid levels, I believe that growth in leisure travel would more than offset the fall in business travel. Furthermore, falling business travel volumes would hurt airlines more, as compared to a ground handler like SATS, because airlines earn a significant proportion of their revenue from business class passengers, whereas I believe that the differential in revenue to SATS from a business class traveler and an economy class passenger is much lower. 

Current projections are that the aviation volume would only return to pre-Covid levels by 2024. Hence, I think the key question that we should be asking ourselves as investors or potential investors would be - at the current level of losses, can the company's cash burn rate be sustainable until 2024?

The answer to this question is by no means straightforward. In addition to economic factors, there are regulatory and policy decisions, as well as the likelihood of an effective vaccine, that would affect our projections. But looking at SATS' cost structure and cash burn rate would be a good start.

Cost structure 

Staff costs make up the largest proportion of operating costs for SATS, at 39% for this quarter. This compares with 57% in ordinary times. One reason for the reduced staff costs was the $61.7m of government reliefs received from the Jobs Support Scheme (JSS). The JSS was extended in August to cover wages up to March 2021, but the co-funding was reduced to 50% of wages (capped at gross wage of $4,600) instead of 75% previously for the aviation industry. 

Depreciation costs are mostly non-cash in nature, however, with the change in accounting standards due to IFRS 16, right-of-use assets are depreciated as well, hence a portion of the depreciation costs actually represent an outflow of cash for the current year.  

Operating cash flow was -$61.1m for the quarter. Comparing this to PATMI of -43.7m, and accounting for depreciation of $33.5m (largely non-cash expense apart from IFRS 16 changes), I believe that the difference may be due to the timing of receiving the JSS grants of $61.7m. For example, the JSS payout computed based on wages in June to August 2020 would only be paid out in October 2020. Capex came in at $10.4m, comparable to Q1 FY20 which was also $10.4m. Hence, we are looking at a free cash flow of around -30m to -40m for this quarter if the cash received from the JSS payouts were adjusted for.

Cash position

SATS currently has a cash position of $723.5m, an increase which is mainly due to the increased borrowings. Debt to equity ratio of 42% (55% if IFRS 16 was considered) as compared to 26% the previous quarter seems moderately high to me, but the total debt of $876.1m as compared to the cash position of $723.5m puts things into perspective. 

Assuming SATS continues a cash burn of around 30m to 40m per quarter (this assumption largely hinges on JSS payouts), then it seems possible that the company would be able to ride out the storm, given that hopefully, the worst quarter is behind us, and aviation volume gradually increases.

Closing thoughts

The aviation industry's troubles are unlikely to go away soon. Airlines are still in trouble. SIA reported that within 2 months, it has burnt through half of the $8.8 billion raised through their rights issue in June. 

Budget carriers may be at greater risk as compared to national flag carriers, due to the lack of state support - governments have vested interest to bail out their national flag carriers as opposed to budget carriers. Would this bode well for SATS when demand returns? Possibly, given that budget carriers, without the inflight meals, SATS earns less per passenger.

For me, I would prefer to bet on SATS for a recovery in aviation, rather than on airlines, mainly due to the differences in cost structure and cash burn rate.


Note: As of writing, hold a long position in SATS at an average price of $3.41. 

Disclaimer: This article is intended for informational and discussion purposes only, and do not constitute financial advice. When in doubt, please contact a licensed financial adviser.


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Should HDBs be Sold at Cost Price?



Should HDBs be sold at cost price?

I felt that this would be an appropriate time to write about the issue of HDB prices, as housing affordability is a huge concern of the general population, given that around 80% of us live in public housing. This is a rather radical idea, and I wanted to provide a balanced view on the practicality of this idea.

Firstly, there may have been a long-standing misconception that “HDB prices would keep appreciating”, perhaps due to the words of certain prominent figures in the past. But now, it is clear that we would be foolish to think HDB prices would appreciate forever, as ultimately, they are sold on 99-year leasehold titles, which means that they would be returned to the state with zero compensation once the land lease expires.

In fact, earlier this year, 191 units in Geylang were returned to the state with zero compensation when their 60 year leasehold titles expired. Thus, with housing affordability a key concern, can new BTO flats be priced at more affordable levels for Singaporeans?


What percentage of the cost of building HDBs comes from the cost of the land?

I think the first issue to clarify would be – when we buy a HDB flat, how much of the total price is attributed to the cost of the land? In this answer by the Ministry of National Development, it was stated that “the land cost was about 60% of total development cost, and this percentage was about the same across 3-, 4-, and 5-room flat types”. Additionally, it was also mentioned that “HDB’s total development cost cannot be fully covered from the sale price of flats”.


What happens if HDBs are sold at cost?

During my teenage years, I was already keenly aware of the implications of our housing policies, and long held the view that HDBs should be sold at cost price. However, as I grew to understand the intricate links between real estate prices, the financial system, and our economy, I realised that selling HDBs at cost price may not be a practical solution after all.  

For the sake of simplicity, let us just assume that if a 5 room HDB flat is sold at $500,000, 60% ($300,000) of the price is due to the land cost. Thus, if the HDB flat were to be sold at only the development costs of the flat, then logically, the new 5 room flat can be sold for as low as $200,000.

What would be the impact of this? Firstly, which is clear, the government would lose revenue from the sale of land, although there would be no direct impact on budget expenditure, given that proceeds from land sales are not included in the budget statement. This would be discussed further in the later paragraphs.

But more importantly, it is about the impact on the existing housing market. Selling new HDB flats at cost would probably be detrimental to existing homeowners. A relatively new resale 5 room HDB flat may transact at around $700,000 to $800,000 currently, but imagine if new 5 room HDB flats entered the market at $200,000, would people still be willing to pay $700,000 or more for a resale flat? Surely, selling new flats without including the land cost would cause the resale market to correct downwards. While selling new flats at $200,000 would be popular with first time homeowners, the negative impact on existing home owners would be far worse. This would also have a domino effect on the mortgage market, our banks and the financial system – the HDB prices backing these mortgages would fall significantly, potentially leading to margin calls; if homeowners are not able to top up their equity, there may be foreclosures and fire sales.

Hence, from the moment HDB started its practice of purchasing land at market prices in 1985, there was no turning back, as any attempt to significantly lower prices by excluding land costs would adversely impact the existing housing market – a policy that no rational existing homeowner would support.

Potential solution?

Given that we now understand the negative implications of selling HDB flats at cost price, what would be an appropriate solution? Interestingly, data from MOF showed that the median household income in 1980 was around $12,000 annually, while a new 4 room HDB flat in the early 1980s costs $55,000, implying a price to income ratio of around 4.6x. Recent prices of new BTO flats today also gives us a similar price to income ratio of around 4 times. Do note that CNA’s article used figures from Punggol BTO launches when comparing prices, not more central estates.


If the price to median income ratios have remained relatively stable, why do we Singaporeans often complain about unaffordable housing prices?

The key here would be to dig deeper into the statistics. Note that the calculations for price to median income uses household income, which takes into account the wages of the entire household. In the 1980s, the labour force participation rate of women was around 40% in 1980, while in 2019, the female labour force participation rate was around 61%. Hence, by using household income as a benchmark, this figure has in part been driven by the increased number of women working, which increased household income.

While a sole breadwinner in the 1980s may find public housing affordable, an increasing number of families today are dual income families, which may somewhat explain why the price to median household income remains relatively unchanged. Hence, is it still right to say that housing affordability has not changed?

Therefore, I believe that public housing can still be made to be even more affordable. My main solution would be to set a cap on HDB prices for the foreseeable future – perhaps for the next 5 to 10 years, to allow wages increase, lowering the price to median income ratio further below 4x. During this period, new HDB prices should only be held steady or reduced. This would mitigate the negative impact on the resale market as well.

Impact on government’s budget

Covid-19 has allowed us to see the importance of running a budget with fiscal prudence in mind, and diligently saving away any budget surpluses to deploy them in a rainy day. Thus, any policy decision should account for the impact on government revenue and spending. 

Interestingly, land sales revenue does not form part of the budget statement, the reason being to avoid “a situation where the Government of the day sells land just so that they can meet their expenditure needs”. However, Singaporeans still benefit from land sales revenue, as these proceeds go into the reserves, which then provides the net investment returns which are included in the Budget.


As per data from the government’s revenue and expenditure estimates, proceeds from land sales were around the $14 billion range in the past two years. It would be good to note that this amount consists of sale proceeds from residential (public and private), commercial, and industrial land. Hence, capping the prices of new HDB flats may not significantly impact the proceeds from land sales. Additionally, as mentioned in the Yahoo article, HDB pays approximately $2,000 psm to acquire land from the government in mature estates, while private developers pay around $7,000 psm. Hence, private developers still pay a huge premium for land as compared to HDB, the overall impact of capping new HDB prices would not be as significant.


Conclusion

In conclusion, I believe that owning a HDB flat should be seen as a right for all Singaporeans. And the issue of affordability has to be addressed as well – no one should be subjected to take out a 20 or 30 year mortgage just to purchase a roof over their heads. 

Thus, while measures should be taken to increase the affordability of HDB flats, these measures cannot be too drastic that the current housing market adversely affected. Hence, in my view, setting a ceiling on HDB prices for the foreseeable future may be the most appropriate policy.