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Thoughts on SATS' 1Q results (SGX:S58)

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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