Investment BAFI 1045

SATS LTD

Valuation Report

Name Student Number FIN Number

Chau Terrance S3418126 G0799971U

Course/ Subject: RMIT Economics and Finance(F/T)

Due date: 27 August 2013

Disclaimer The advice provided in this report is general advice only. Before acting on this advice you should consider your financial situation, objectives, needs, or seek advice from a licensed individual. Terrance Chau shall not be liable for any loss or damages whatsoever arising from the use or reliance on the information provided in this report.

Executive Summary

SATS Ltd. Is a company that operates in the Aviation gateway sector as well as having operations in

Food solutions. They have operations in 10 different countries and are present in over 30 airports

around Asia. It should also be noted they hold a 80% market share at Changi International Airport in

Singapore.

SATS reported a 7.9% increase in total revenue for the year ending 31st March 2013. Their revenue

comprises of 64% from Food solutions, 35.7% from Gateway services and 0.3% from others. The

return on equity this year was 13.41% up from the 10.70% of the previous year. This may be main do

to better efficiency with a 91% total asset turnover.

In this report, two discounted cash flow methods were used to evaluate the intrinsic value of SATS

share price.

DDM FCFE

Price $3.12 $3.60

The results of both methods are shown in the table above. The limitations, estimations and reasons

for the difference in values are detailed in this report.

We also used market test ratios to compare its performance against the sector. I came up with the

following values:

In conclusion, a mix of discounted cash flow analysis and ratio analysis was deemed the best

methods to valuate SATS. I recommend a Buy for SATS with an estimated value of $3.50.

All assumptions are included in this report.

1. Company Background

1.1 Overview

SATS is a Singapore based company that first listed on the SGX in May of 2000. They started off in

the Aviation Gateway sector and have since expanded into the food industry. They have also

expanded operations into 10 different countries; operating in 30 different airports. They have also won

the ‘Best Air Cargo Terminal in Asia’ for the 15th time this year.

Services in Aviation Gateway Sector include:

airfreight, baggage, and ramp handling

passenger services

aviation security

cargo

warehousing

perishables handling

cruise handling

terminal management

Services in Food Sector include:

airline catering

food distribution and logistics

industrial catering

chilled and frozen food manufacturing

As we can see from Figure 1 below, the Aviation sector makes up approximately 80% of SATS

revenue. Food solutions also make up 64% of SATS revenue. This shows us that a large portion of

SATS total revenues comes from airline catering.

SATS main operations are at Changi International Airport where they hold approximately 80% of the

market share. They have also gained new contracts with customers including Air India express,

Fedex, lufthansa Cargo and United Airways. Along with renewing contracts with several customers

such as China eastern Airlines, China Southern Airlines, eVA Airways, Korean Air, Singapore Airlines,

Swiss International Airline.

Figure 1 (SATS 2013)

1.2 Share Performance

Figure 2 (Yahoo 2013)

In Figure 2 above shows the returns of SATS from when it first listed on the SGX until August 2013 in

comparison with the STI. It can be seen that SATS moves generally in the same direction as the STI.

It is also important to note the large dip in returns starting from the end of 2007 until the beginning of

2009 due to the Global Financial Crisis. This may be cause by the services of SATS being a derived

demand of the Airline industry (explained further in Section 1.3).

Figure 3 (Yahoo 2013)

In Figure 3 above, we take a look at a relatively more recent performance of SATS share price using

August 2011 to August 2013 as the time frame. Again, we compare this with the STI as the

benchmark. We see that if an investor was to buy a SATS share in August of 2011, he would earn a

return of 50% compared to the approximately 12% of the STI. We can also observe a large dip in

August 2012, this dip is primarily due to the 26 cents dividend SATS paid out that year. We also see a

climb in prices in May of 2013, this could be primarily due to the announcement of Mr Tan Chuan Lye,

the current CEO, retiring and Mr Alexander Charles Hungate to take his place.(Straits Times, 2013)

1.3 Macro Outlook

1.3.1 Exchange Rates

Figure 4 (Yahoo 2013)

One important macroeconomic factor that may affect the revenue of SATS is the exchange rate.

Because SATS has operations in 10 other countries, the exchange rate between the Singapore

Dollar and the currencies of these countries will have a large impact.

Operations from TFK in Japan made up 18.4% of the total revenue for the year ending 2013. If

Japan’s Q2 GDP figures are disappointing, they may renew quantitative easing measures

bringing the value of the Yan even lower (DailyFX, 2013). In Figure 4 above, we look at the

exchange rate between the Japanese Yen and Singapore Dollar. We notice an upward trend in

the graph indicating that each Singapore Dollar is worth more and more Yen. This means that,

keeping prices and sales constant, revenue from Japan operations will decrease relative to the

Singapore Dollar where SATS is based.

1.3.2 Consumer Confidence and Interest Rates

Figure 5

The interest rate has effects both on the consumer and on a business. In the case of SATS, the

interest rate has relatively little impact as they have very low gearing. However, low interest rates

shown in Figure 5 above, do encourage consumers to spend more.

As mentioned above, SATS relies heavily on the Airline Industry as its business is a derived demand;

in-flight catering, cargo and passenger handling, etc. As the world recovers from the recent Global

Recession, people are regaining confidence and are able to have more income to travel. Last year,

the Airline Industry in Singapore saw an 8.7% increase in passenger traffic as well as a 6.8% increase

in the number of flights. This I feel is directly linked to the 7.9% increase in revenue of SATS.

Another factor we must take into consideration are events such as the recent haze and the 9/11

attacks. With respect to the recent haze, Singapore’s tourism sector was hugely affected. This into

has negative impacts on SATS because of the reduction in Air traffic. The 9/11 attacks similarly had

such an effect on SATS. As we can see from Figure 2, after the 9/11 attacks there was a huge drop in

the returns of SATS. This is attributed to people being afraid to fly in turn, also reducing the amount of

air traffic.

1.3.3 Government Regulations

Government regulations also play a large part in the profits of a company. Since SATS has expanded

operations to other parts of Asia as well as the Middle East, we not only have to take into

consideration of the Singapore government but also the government of the other countries.

Over the past few years, Singapore has been reducing corporate tax rates. The corporate tax rate

was 20% in 2005 and has dropped to 17% since 2010 as well as additional tax rebates (IRAS, 2013).

This would increase the profits of a company holding everything else constant.

The Middle Eastern countries are extremely volatile. It may be said to a certain extent, a crisis can

break out at anytime. This will have hugely negative impacts on the revenues and profits of SATS.

1.4 Mirco Outlook

1.4.1 Competitors

There are two main competitors for SATS. The first is Changi International Airport Services, now

known as DNATA. The second company was rewarded a license to operate at Changi Airport in

2011. However I feel that the new and existing competition will not affect SATS much. This is due to

the size of SATS allowing it to survive and even dictate any price wars should they take place. SATS

has many integrated services that may help to promote customer loyalty. Detailed ROE analysis

between DNATA and SATS will be explained in Section 1.5 of this report.

1.4.2 Operations

SATS operations are largely diversified (See Section 1.1). By having operations in different sectors

and different countries, they are able minimize losses when a certain sector is affected. This can be

seen in their latest financial report where operating profit for the gateway services sector fell by

approximately 50% but operating profits from Food solutions grew approximately 38% leading to an

overall increase in profit after tax.

1.4.3 Management

In May of 2013,SATS announced the retirement of Mr Tan Chuan Lye, the current CEO, with Mr

Alexander Charles Hungate to take his place. Share prices rose along with the news. Mr. Hungate

was the Chief Executive for HSBC’s operations in Singapore and bring along with him a depth of

expertise. However, I feel that any change in management could bring a negative or positive impact to

a company in the beginning. Only time can tell if Mr. Hungate will bring the company forward.

1.4.4 Reputation

SATS has a very good reputation in Asia. Not only does it have an approximately 80% market share

and long term contracts with major airlines, such as SIA, it has also won many awards. These awards

include:

‘Best Air Cargo Terminal in Asia’ title for the 15th time at the Asian Freight & Supply Chain

Awards 2013 organized by Cargonews Asia

joint Silver Award for Best Managed Board at the Singapore Corporate Awards 2012

Distinction Award at the inaugural Human Capital Breakthrough Award for being one of

Singapore’s boldest and most innovative companies in the field of people management.

These awards help give SATS credibility and will help to draw in more business opportunities in the

future.

2. DuPont Analysis

The return on equity, ROE, is a measure of how well a company uses shareholder’s money to

generate profits. In other words this means how much money the company is earning for the investor

(Financial Times, 2013). The DuPont identity breaks the ROE into three different factors (CFA

Institute, 2013):

Profitability-How profitably you are running your business

Efficiency-How well assets are used to generate gross profits

Financial Leverage-How much debt a company uses to finance the generation of revenues

While the extended DuPont identity breaks it down further with:

Tax Burden-How much tax is the company paying

Interest Burden-How much interest is the company paying

This allows us to analyse where the value of the company is coming from. It also allows us to see how

well the company is managed by the way its resources are used. However, this method of valuing a

company does not take into consideration the risks of the market.

To make more sense of the numbers, we will need to compare it with companies in the same industry

as different industries have different means of operations.

2.1 Operating Profit Margin

As we can see from the table above, the operating profit margin of SATS has declined from 15% to

13% from 2011 to 2012. This tells us that SATS has been losing profitability in that year. This may be

due to increased cost such as the increased cost of labour. However, DNATA’s operating profit

margin is relatively near SATS so we can conclude that SATS is still doing well relative to the

industry.

2.2 Total Asset Turnover

Over the three years, we see increases in the efficiency of both companies. We see relatively larger

increases in the efficiency of SATS, eventually being more effective than DNATA in 2013.

2.3 Interest Expense Rate

This ratio shows that the percentage of interest relative to their total assets has increased. It is

important to note that DNATA pays nearly four times as much interest which may indicate higher

levels of debt.

2.4 Financial Leverage Multiplier

This multiplier shows us how well the company is using debt to multiply earnings. The multiplier of

DNATA is relatively higher than SATS. This means that DNATA is using more debt to multiply its

earnings. However, having a higher multiplier also makes the company riskier.

2.5 Tax Retention Rate

This is how much the company retains of every dollar they make after expenses. The increase in this

figure for SATS may be due to the increase in interest expenses. As interest is paid before tax, it can

form a ‘tax shield’ reducing the amount of tax paid. This can also be seen in the tax retention rate of

DNATA.

2.6 ROE

With respect to the ROE of both companies in the last three years, SATS has shown a constant

growth whereas DNATA has been quite volatile. A large portion of the constant growth may be due to

the increase in efficiency as shown by the total asset turnover. We also note that DNATA has a

generally higher ROE compared to SATS. This is due to the higher use of financial leverage to

multiply earnings. It may be said that SATS is not taking advantage of debt to increase earnings,

however I feel SATS is fundamentally sound and they should not increase risk by using more

leverage to obtain a higher ROE which may ward off some investors.

3. Capital Asset Pricing Model

The Capital Asset Pricing Model(CAPM) gives us the relationship between risk and returns using the

formula below.

where:

is the expected return on the capital asset

is the risk-free rate of interest such as interest arising from government bonds

(the beta) is the sensitivity of the expected excess asset returns to the expected excess

market returns

is the expected return of the market

I have chosen the CAPM model over the Arbitrage Pricing Theory model because I feel that SATS

has generally moved in tandem with the market (As seen in Figure 3). I have also assumed that many

macroeconomic factors such as GDP and consumer confidence have already been factored into the

returns of the market. Therefore the CAPM is sufficient to calculate the required return of SATS.

The risk free rate of interest is the rate of return an investor will get for no risk at all. For the purpose

of this calculation, we will use the Singapore CPF rate of 2.5% as the risk free rate. This is based on

the assumption the Singapore government is stable and there is no risk of the country going bankrupt.

For the expected return of the market, a few more assumptions need to be made. Firstly, as stated

above, I believe that macroeconomic factors have already been factored into the returns of the

market. It is also not possible at this stage to assign appropriate probabilities to the different variables.

Therefore, for the expected returns of the market, I used the returns of the STI over the last 10 years.

On the STI moved from 1,291.61 on 31st January 2003 to 3,291.94 on 1

st February 2013 which

represents an annualized average of 9.8%. Dividends then increased 9.8% to a 12.7% yearly

average. However, since dividends may not be paid regularly by all companies and I believe we

should take a conservative approach, I have used 10% as the expected return on

markets.(MyStocksInvesting, 2013)

Lastly to use the CAPM, we need to calculate the beta. Beta can be calculated using the covariance

of the stock and the market divided by the variance of the market. For the purpose of calculating beta,

we will use the STI as the market proxy. I have also chosen to use a time frame of three years. This is

because using a time frame that is too long may affect the beta as companies have gone through

major changes. It also only takes into consideration the time frame after the global financial crisis as

the crisis would make our beta higher than it should be. The interval used is weekly due to the fact

that shares are not traded over the weekends and if we take them into consideration, it may affect our

beta.

By using regression analysis of weekly returns of SATS against the weekly returns of the STI, we are

able to get the slope of the regression line which represents the raw beta. We then have to adjust the

beta towards 1. This is due to the fact that over time, companies will diversify and expand. As they

expand, they will represent more of the market through a higher market cap.

To adjust the beta, we use the formula:

Adjusted Beta=Raw Beta*(0.67)+1*(0.33)

The table above shows all the factors we need to calculate the expected return of SATS.

The expected return for SATS is 8.33%. This value will be used as the expected returns and cost of

equity for valuation methods later in this report.

4. Dividend Discount Model

The dividend discount model uses the sum of future values of all dividends as the price and investor

would pay for a stock. This is based on the assumption that shares never mature and there is an

infinite cash flow in the form of dividends to be paid. Below is the formula of the dividend discount

model.

Value of preferred stock

For this model to work, we must make the assumptions that dividends grow at a constant rate. We

must also assume that the required rate of return, or k, is greater than the growth rate. It is also

important to note that only ordinary dividends are included in this calculation as special one off

dividends are not guaranteed so they are not accurate and may cause irregularities in the growth.

By using a arithmetic mean of the year on year growth rates, we get an average annual dividend

growth of 4.64%.

With the information above we are now able to calculate the value of SATS using the DDM.

Based on the DDM model and the above calculations of k and g, the price of SATS should be $3.12.

We now need to determine how sensitive this model is to change. This will help determine

irregularities and uncertainty in the model if there are any. Because this model is heavily reliant on the

payout of dividends and the growth rate, we should see how changes in both these factors affect the

price of SATS

There are a few things we can observe from the sensitivity analysis above. First and most importantly,

we see that if there are no dividends paid, this model would be useless. We also observe that at any

give growth rate, a one cent increase in dividends increases the share price in a linear fashion. For

example at a growth rate of 2.64%, every one cent of increased dividends increases the share price

by approximately 18 cents. However, with a fixed dividend, any increase or decrease in the growth

rate changes it exponentially. From this we could conclude that the accuracy of our growth rate is a

key factor in determining an accurate price for SATS.

5. Free Cashflow For Equity Model

FCFE is derived from the following formula:

Net Income0

+Depreciation and Amortization (DA)

-Capital Expenditures (CapEx)

-Change in Net Operating Working Capital (ΔNOWC)

-Debt Principal Payments

+New Debt Issuances

= FCFE0

Or

As we can see from the first formula, FCFE represents the cash that is available to shareholders. This

assumes that all the cash available to shareholders is paid out in the form of dividends with no

retained earnings.

From the table above, we see that from 2012, the FCFE has grown by 340%.this is attributed by the

higher NPAT and the change in working capital.

In order to predict the present value of SATS, we must discount back all the future FCFE per share.

To do this we must also predict the future growth rate of the FCFE. I believe that SATS will expand

over the next few years. This is due to the increase in air traffic as the economy recovers from the

recent recession. The recent change in management may also play a part as the new management

may have new innovative ideas that would require an increase in working capital. After this

expansionary phase, I expect SATS be well diversified in terms of market sector and geographically. I

believe SATS will be able to maintain a stable growth of 2-3% after its expansionary phase. This

estimate is based off the revenue of SATS growing by approximately 9% each year for the past 5

years. As revenue increases, tax will also increase and more labor may be required. Also there is an

increase in competition as mentioned above; leading to a lower growth in FCFE.

From the table above, the intrinsic value of SATS using the FCFE valuation method is $3.60.

From the sensitivity table above, we can see that the growth during the stable growth stage attributes

to a large increase in the intrinsic value of the share when it increases. This shows that investors are

ready to pay higher prices as the growth rates increases. However, this also shows that a slight

misestimating of the growth can cause the intrinsic value of the stock to be completely wrong,

6. Ratio Analysis

To calculate the following ratios we must determine the earnings per share(EPS). This is calculated in

the 3 year snapshot prepared below.

6.1 Price/Earnings Ratio

The P/E ratio can be calculated with the following formula:

The payout ratio is expressed by Dividends/Earnings.

From the table above, we can see that the P/E ratio of SATS is 17.26 which means investors are

willing to pay $17.26 for every $1 of returns. This number alone however, is useless. We must

compare it with companies within the same sector or with the sector itself because different sectors

will have different P/E ratios due to different investor expectations. In the case of SATS, the P/E of the

sector is 21.1 which means investors are willing to pay $21.10 for every $1 of returns. This could

indicate SATS is still undervalued.

As for the future P/E ratios, we see an increase in the forecasted ratio in 2014 and then a drop in

2015. This may be due to the fact that investors are losing confidence in SATS LTD or we are limited

on our dividend growth (using the 4.64% calculated above) and obtained a payout ratio that is lower

than expected. This would cause our 2015 forecasted P/E ratio to be inaccurate.

We can also use the P/E ratio of the industry to find the value of SATS. We use the P/E ratio of the

industry because we want to determine how much should be paid for SATS relative to the industry.

This allows us to compare the current price with how much it should be in this industry. By

manipulating the formula above we get the equation

V=EPS*P/E with V being the value of the stock.

Using this formula we find that the value of SATS should be $4.02.

As with the other models, we must examine the sensitivity of this model to change. From the table

below, we see that an increase in one cent of dividends increases the P/E ratio by approximately

1.57. This means that investors are ready to pay an extra $1.57 for each extra cent of dividends at

this give time frame. From here we can conclude that if our dividend grow is not calculated correctly, it

could greatly affect the future P/E ratios.

6.2 Price/Book Ratio

The Price/Book ratio is used to determine if a stock is undervalued by comparing its price against its

book value. In general, an investor should look for mismatches between the ROE and P/B ratios. For

example, low P/B but high ROE and vice versa.

It is given by the formula below.

The P/B of SATS is lower than the P/B of the sector which coincides with the above P/E analysis that

SATS is currently undervalued. However, we see a general upward trend in the forecasted P/B ratios.

This further supports the claim that SATS is undervalued, because assuming an efficient market,

investors will pick up on the fact that it is undervalued and prices will rise accordingly to match what is

expected from the sector.

Another formula for the P/B ratio is P/B=P/E*ROE. By using this formula, we are able to determine a

value for SATS. Again we use the P/E of the sector to get a relative measure of SATS against the

sector.

Using the above formula, we get a value for $3.80. This also shows that SATS is undervalued as it is

currently trading at $3.13

6.3 Price/Sales Ratio

The Price/Sales ratio is another market testing ratio because sales are subject to less manipulation

whereas earning and profits may be ‘window dressed’ in the financial statements.

The formula is given as:

We see that the P/S ratio remains nearly constant in the forecasted years. From the table we can

derive this consistency due to a decrease in net profit margin offsetting a higher payout ratio and vice

versa.

The lower the ratio is the better the stock is because investors will be paying less for each unit of

sales. However, sales do not take into consideration other factors such as debt and tax. It is also

important to note that P/S ratios assume that all companies have the same capital structure.

However, we know that the capital structure varies very much between industries. Therefore this ratio

is only useful for evaluating companies that do not have a P/E ratio and for companies in the same

industry.

We are able to find the value of SATS using this ratio by using the formula:

P=P/E*NPM*Sales

Using the P/E of the sector, we are able to value SATS at $3.82.

7. Conclusions

In my opinion, all the models used in this report has their limitations and advantages. With both the

DDM model and the FCFE model, there are many assumptions to be made starting with the values

we use for our CAPM. The required rate of return used for both models were derived using the

CAPM. The main assumptions in the CAPM were the return on markets and the values we used to

calculate the beta, eg. The time frame of data collected.

One problem with the DDM is determining the growth rate of the dividend. As SATS has been paying

an 11 cent ordinary dividend for the past 3 years, it may also be assumed that the growth rate of

dividends is 0%. This is because most companies as they mature would not want to grow their

ordinary dividends. This is due to the fact that investors will be expecting such dividends with

additional growth. But during times of low profitability, the company may not be able to grow dividends

and in worse scenarios they may even have to pay less because after all, dividends are profits of the

company for shareholders.

I valued SATS at $3.12 using the DDM model. As of the 16th of August SATS was trading at $3.13 ex-

dividend. This shows that SATS is trading at its intrinsic value. But this may not be the case as SATS

occasionally pays out a one off special dividend which some investors may be looking for. These

investors would take these special dividends into consideration when calculating the value of SATS.

As we did not have any concrete way to estimate the growth of FCFE, the model may be inaccurate..

This can be shown in the sensitivity analysis above. It shows huge changes in the value of the share

with only a 1% change in growth rate. However, I tried to justify the growth rates used in my

calculations with my macro and microeconomic outlook.

Lastly, looking at the different market test ratios, they are relatively meaningless unless you compare

them with other companies in the sector. However, even while comparing, there are a few factors that

make each of them unreliable without further analysis to back them up. In terms of the P/E ratio alone,

it does not give us any useful information as it could be interpreted in different ways. For example, a

high P/E ratio could mean that the stock is safe and investors are willing to pay more for $1 of

earnings. On the other hand, it could also mean that the price is overbought. There is a need to do

further analysis to determine which it is. The P/B ratio is useful for mergers and acquisitions because

it can value companies that are likely to go into bankruptcy. However, this ratio does not take into

consideration such as inflation or intangible assets. Both these ratios are also limited due to

tampering of financial statements that companies use to make them look better. Finally we have the

P/S ratio. This ratio may be preferred by some because it shows how much you are paying for each

unit of sales and sales are less vulnerable to manipulation. However the ratio does not take into

consideration taxes and debt. These are both important factors as different companies may have

huge differences in capital structures.

In conclusion, I feel that the best model to use to determine the value of SATS was a mix of the DDM

due to them having a steady stream of dividend pay outs, together with FCFE and ratio analysis. As

ratio analysis is meaningless alone, the DDM can be used to support the values obtained from the

ratios. Combining the values from my analysis, as well as my economic outlook, I have estimated

SATS to be valued at $3.50. I recommend a Buy for this stock as it has potential to grow above the

current $3.13 it is trading at.

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