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Edited Transcript of S58.SI earnings conference call or presentation 12-Nov-19 10:00am GMT

Q2 2020 SATS Ltd Earnings Call

Singapore Nov 14, 2019 (Thomson StreetEvents) -- Edited Transcript of SATS Ltd earnings conference call or presentation Tuesday, November 12, 2019 at 10:00:00am GMT

TEXT version of Transcript

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Corporate Participants

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* Alexander Charles Hungate

SATS Ltd. - President, CEO & Executive Director

* Carolyn Khiu

SATS Ltd. - VP of Public Affairs & Branding

* Shi Yun Ang;AVP Group Finance

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Conference Call Participants

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* Ahmad Maghfur Usman

Nomura Securities Co. Ltd., Research Division - VP

* K. Ajith

UOB Kay Hian Research Pte Ltd - Director of Asia Transport Research

* Rachael Tan

UBS Investment Bank, Research Division - Associate Director & Research Analyst

* Shaun Tan

Crédit Suisse AG, Research Division - Analyst

* Siew Khee Lim

CIMB Research - Head of Research for Singapore

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Presentation

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Operator [1]

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Second quarter financial year 2019-2020 earnings conference call.

Before we begin, SATS would like to remind you that certain comments made during this call may contain forward-looking statements. Many of these forward-looking statements can be identified by the use of words such as may, will, expect, anticipate, estimate, assume, continue, project, plan and similar words and phrases. The company's actual results and future financial condition may differ materially from those expressed in any such forward-looking statement as a result of many factors that may be outside the company's control, including, but not limited to, changes in the business environment. The company does not undertake any obligation to update its forward-looking statements.

I will now hand over the call to Carolyn Khiu of SATS. Please go ahead.

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Carolyn Khiu, SATS Ltd. - VP of Public Affairs & Branding [2]

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Hi. Thank you, Serena. Good evening, everyone. Welcome to this web call. A while ago, SATS released our results for the second quarter FY '19-'20. With me here are Alex Hungate, President and CEO of SATS. Manfred is unable to join us on this call, and in his place, Ang Shi, AVP for Group Finance, will be standing in for him.

I think you're all anxious to review the results. I hand you over to Alex, who will take you through it.

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Alexander Charles Hungate, SATS Ltd. - President, CEO & Executive Director [3]

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Thanks, Carolyn. Good evening, everybody. And I should probably explain on Manfred's behalf. He's had a minor eye surgery, so that's why he can't join us. Otherwise, I know he never want to miss the call. But be assured when he returns, his eyes will be sharper than ever. And that's what we want from our group CFO. So let me kick off.

We're starting with an update on the growth plan that we unveiled on our Capital Markets Day at the end of our last financial year. So we wanted to give you an update on how that's going. You can see that the revenue has been growing, and we'll return to that shortly, but we do disclose some of the volume attributes and that's what we've done on the slide here. You see the map, which we're showing. The volume increases between first half last year and first half this year. So passengers have grown by 55% to 45.7 million. That's mainly because of the consolidation of the passenger volume from GTR in Malaysia. But we have generated passenger volume growth in Singapore as well.

In terms of meals served, it's increased 3.8% to 39.7 million. Again, there was growth in Singapore as well as in Japan. And you'll see the revenue growth in Japan later on in the presentation.

Flights handled more than doubled, 124% growth, and that is mainly due to the inclusion of all the flights from GTR in Malaysia. But again, we have seen flight handling growth volumes in Singapore despite the fact that Changi has announced that their flight volumes decreased slightly, ours had increased slightly. So we seem to be winning market share there.

Cargo is the negative part of the quarter's story, continuing the story from last quarter and related to the global trade situation. So cargo handled overall fell by 2.5% to 911,000 tonnes in the first half. This is a combination of 2 impacts. Continuing drop in Singapore. This quarter, it was close to 6% drop. But we added some tonnage out of Malaysia with the beginning of GTR starting to handle cargo in Malaysia. So that's a new business line for them, which we flagged to you last quarter. So we're seeing just a small amount

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Operator [4]

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Ladies and gentlemen, please stay on the line. The conference will begin shortly. Once again, please be on the line, the conference will begin shortly.

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Carolyn Khiu, SATS Ltd. - VP of Public Affairs & Branding [5]

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Okay, we can proceed.

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Alexander Charles Hungate, SATS Ltd. - President, CEO & Executive Director [6]

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Okay, good. Sorry, you got cut off there, which, hopefully, everyone can hear us now.

So we were talking about the critical issue of cargo volume. So we said that, overall, the group handling of cargo dropped by 2.5%. That's a combination of a small increase in Malaysia from the start-up of our cargo operations in GTR and then a 5.7% drop in Singapore. That is a lower drop again than the cargo volume change that the Changi Airport published. They published 7.6%. So we seem to be outperforming the market in Singapore, even though it's a falling number. Okay. So those are -- that's an indication of the volumes, which are in line with the growth strategy that we set out at Capital Markets Day.

You can see on the next slide, some of the many activities that have occurred during the quarter. So here in Singapore, we bought out our Brazilian partner in the food distribution and trading business called SATS BRF, which we've now renamed Country Foods. That gives us 100% owned entity that we can use to drive our digital integrated supply chain initiatives across the region, which, over the long run, is going to be one of the ways in which we remain cost competitive and manage raw material cycle prices as they go up and down. And it's also the way in which we can secure long-term sustainable supplies going forward. That business will link up with the food trading businesses that we're starting in China and India to give us a scale benefit across the region.

Also in Singapore, we announced a partnership with DHL so that we could enhance our food logistics capabilities around the region and better serve the airlines across their full network. And we began rolling out our COSYS+ network, which is the digital network that we talked about at the Capital Markets Day, that we've successfully rolled out here in Singapore. And also, in Daxing Airport, the new spectacular airport that just opened in Beijing.

So turning to that. We started both catering and ground handling operations in Daxing at the start of October. So we are the only independent caterer and ground handler there. So we'll be targeting the large number of international airlines coming to those to Daxing. And we also have already signed up Air China as a base customer there.

We completed the acquisition that we announced last quarter of Nanjing Weizhou Airline Food Company, which, as you remember, serves 85 airports, the smaller airports, but 85 of the 225 airports in the Chinese market. So it gives us a very good platform to grow our catering business across China.

I mentioned Malaysia earlier. So we've begun handling cargo there in October of this year. But the main bulk of the cargo that we will handle will start in January. So we have been investing costs there also to set up a large cargo facility. And we've also opened the Malaysia's first digital control center for managing the airport in KL.

In Japan, we've also been growing. You'll see later that the revenue has increased by almost 7% this quarter versus last year. That's because there's a lot of inbound tourism into Japan. And the -- in particular, Haneda Airport has been increasing the number of slots, the number of landing slots. So it will be up to 52 landing slots by April 2020. So that would be a significant increase from today. And we've been winning new customers there. And we've increased the size of our kitchen in Haneda. So the capacity will almost double in that kitchen. As you remember, we also have additional capacity in the Narita Airport, which we hope we'll begin to fill up as that inbound tourism increases in Japan.

All right. Turning to the next page. Here, now, we start to talk about revenue. So that's talking about the volume growth and the strategy implementation. So you can see it's starting to come through in terms of the revenue year-on-year. Singapore, relatively muted because you've got a number of impacts there. But basically, revenue growth in nearly every business with the exception of cargo and the cargo-related businesses in Singapore. So a net impact of plus 2.2%.

Japan, growing, as I mentioned. New customers and new slots available for the airlines there.

Southeast Asia, ASEAN, excluding Singapore, has grown fairly consistently, maybe in line with the trade patterns that we're seeing.

GTR has been growing quickly, both in terms of number of airports served, now up to 18, and number of flights from our base customer, AirAsia, plus the growth into cargo now.

Brahim's has been growing as well. And the profitability has improved.

MacroAsia has been growing and so has TSN, the cargo business in Vietnam, benefiting from the significant trade flows that we're seeing on a macro basis into Vietnam.

Greater China is down in revenue -- well, actually it's flat in revenue. I guess, it's up in the food business, where we've been growing our revenue out of the new Kunshan kitchen. And then we -- not in this quarter. But I guess, in the future quarters, we'll see revenue growth from Daxing because of that start of October, beginning of operations there. But in this quarter, increase in food revenue from non-aviation, offset by the decrease in Hong Kong, in particular, but also in Taiwan. That's why you see Greater China flat in terms of revenue.

And India is down for the main reason being the absence of Jet Airways from the market, as we talked about last quarter. So no credit losses from this quarter. But obviously, some fall in revenue as the volume from Jet had disappeared from the market, both in terms of catering for TajSATS and also for the Mumbai cargo as well.

Profitability, you can see improvements in Japan, the ASEAN, in line with what we were just saying. A decrease in Greater China, driven primarily by AAT drop in cargo volume, but also investments in Daxing Airport. SATS Hong Kong has actually increased its share and improved profitability slightly to offset those 2 things. And then still investing in new kitchens on the non-aviation side. As you know, we're targeting a new kitchen in Tianjin as well as one in Kunshan, which we are currently operating.

In India, a big decrease in profitability, primarily driven by TajSATS because of the loss of the Jet Airways volumes, somewhat around the cargo operating leverage at Mumbai Cargo as well. So that's in line with what you would expect, I think.

So if you look at the summary then of the second quarter, which is the next slide, group revenue overall grew by 9.8%. This is actually quite fast for SATS. In fact, it's the fastest quarterly growth we've had in the last 10 years since the acquisition of SFI. So it is the beginning of the results of our growth strategy that we announced in the Capital Markets Day. It's primarily driven by the consolidation of GTR and the beginning of the consolidation of Country Foods, which is a partial quarter.

EBITDA continued to grow. So this quarter, it's another growth of 6.6%, $106 million. PATMI, however, decreased because of the increased depreciation and amortization. So that went down by 7.6%. And a small decrease in share of profits from joint ventures and associates as well, a 2.1% drop this quarter. Primarily, as I mentioned, it's the cargo-related volumes which are impacting those. But in addition, you've got the impact of Jet -- the jet loss of revenue at TajSATS as well.

Operating margin dropped by 1.5 percentage points, a combination of a cargo business, the volume drop, which has high operating leverage and then, of course, the investments that we're making in the growth initiatives that I've mentioned earlier in the call. So EPS, down by $0.005 to $0.054. We are maintaining our interim dividend at $0.06 per share.

So with that, I will hand over to Shi Yun. Over to you, Shi Yun.

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Shi Yun Ang;AVP Group Finance, [7]

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Thanks, Alex. Good evening, everyone. I'll take you all through set of financial results for the first half FY '20. We are on Slide 8 for the quarter results.

Group results grew $44.3 million in the second quarter to $497.4 million. Revenue from Food Solutions increased by $20.1 million with growth registered in core subsidiaries as well as consolidation of Country Foods.

Gateway services revenue increased $24.3 million, of which $23 million was attributable to the consolidation of GTR. The growth was partially offset by the decrease in cargo and call center revenue, as a result lower cargo volumes and lower ship costs.

OpEx increased by $45.3 million, of which $35.2 million relates to the consolidation of GTR and Country Foods. Excluding this, there is a lower increase in impact, which is driven by higher IT expenses for digitalization and transformation as well as higher equipment maintenance costs.

EBIT decreased by 1.5% to $65 million, mainly due to lower cargo performance as well as higher OpEx for the quarter.

Share of results of associates and joint ventures decreased slightly by $0.3 million, mainly due to lower performance by cargo associates, and TajSATS as mentioned by Alex earlier, offset by improved contribution by Brahim's. As a result, PATMI decreased by $5 million to $60.7 million.

For the half year results, group revenue grew $70 million in the first half to $962.5 million, with growth in both food and Gateway. Revenue from food rose by 4.5% with growth registered in core subsidiaries. Gateway services revenue increased $48 million, of which $45.5 million was attributable to the consolidation of GTR. The growth is partially offset by the decrease in cargo revenue as a result of lower cargo volume.

EBIT decreased by 7% to $121.8 million, mainly due to lower cargo performance as well as a lower foreign exchange gain in this year.

Share of results for associates and joint venture decreased by $1 million, mainly to the provision of credit losses amounting to $3.3 million, which was explained in first quarter results. Excluding the credit losses as well as the low performance of the cargo associates, share of results for associates and joint venture would have increased by $4.4 million or 15%.

CAS Group, Evergreen as well as AAT, Maldives and the Vietnam Associates remains the top 5 contributor to the share of results.

All in all, PATMI decreased by $14.2 million to $115.4 million.

If we look at -- saw the financial indicators. Group EBIT margin dropped to 13.1% for second quarter and 12.7% in the first half. Consolidation of GTR and Country Foods did not materially affect the EBIT margin. PATMI margin has also lowered to 12.2% for the quarter and 12% for the first half.

EPS and ROE are lower due to the lower reported earnings. NAV per share has lowered to $1.46 per share. Debt/equity ratio has increased to 0.18x. The increase in debt-to-equity ratio is due to recognition of the lease liability that arise from the adoption of the new IFRS standards. Excluding the impact of the new accounting standard, debt/equity ratio would remain healthy at 0.06x.

On Slide 12, we look at the segment revenue. Group revenue has increased by 8% and 4.5% for second quarter and first half, respectively, due to the consolidation of Country Foods and volume growth. Though impacted by lower cargo volume and lower ship calls, Gateway revenue improved by 12% in both periods due to the consolidation of GTR. Gateway has accounted for 45% to the group revenue in this quarter and 47% to the group revenue in the first half.

Aviation continued to account for more than 80% of the group revenue. Increase in

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Operator [8]

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Ladies and gentlemen, please stay connected. The call will resume shortly. Once again, please stay connected. We will resume shortly.

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Shi Yun Ang;AVP Group Finance, [9]

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Hi. Sorry, the call was -- the line was dropped, again. So maybe I'll continue.

Aviation continued to account for more than 80% of the group revenue. Increase in non-aviation revenue is due to consolidation of Country Foods, offset by the divestment of FASSCO.

In geographical terms, Singapore remains a key pillar, accounting for the group revenue. However, for year-to-date September '19, Singapore contribution has decreased from 83% to 80%, while ASEAN contribution has increased by 5% due to consolidation of GTR.

Next, we look at the group expenditure for the second quarter. Group expenditure for the tax -- for the quarter has increased by $45.3 million to $432.4 million due to consolidation of GTR and Country Foods, which in total account for $35.2 million of the increase. If we exclude both the entities and the divestment of FASSCO, group OpEx would have recorded a lower increase of 14.4%. The higher depreciation and amortization charge is mainly due to the adoption of the new accounting standard, and this is offset by the decrease in the premise cost.

Other costs rose due to higher maintenance for ground support equipment, vehicles, et cetera and IT expenses to support these dilution projects.

I'll go on to the group balance sheet. Total equity and total assets stood at $1.8 billion and $2.6 billion, respectively. The slightly lower investment in joint ventures and associates is due to the reclassification of Country Foods for investment in joint ventures to a subsidiary following the acquisition of the remaining 49% equity insurance. And the decrease is partially offset by the capital injection into the Daxing investments, both Gateway and in-flight catering as well as additional injection into KrisShop and also impacted by the share of associates and joint venture results. And due to the adoption of new accounting standards, the group recognized $196 million of right-of-use assets and then correspondingly, lease liability of $198 million as at 30 September '19.

Cash position decreased to $223.6 million following the dividend payment in August '19.

Lastly, we look at the group cash flow statement. Net cash from operating activity has come in at $86.5 million, which is around $16.9 million lower than the previous period. Net cash used in activity -- investing activity was higher, mainly due to the various acquisitions that we have, namely the Country Foods, Nanjing Weizhou, the Daxing investment and as far as the injection in KrisShop, these were partly mitigated by the dividend that we see from the associates and joint venture.

Lastly, net cash in financing activity was lower by $1 million. The cash was used for dividend payments with the amount of lease liability of $6.5 million as well as dividend paid to noncontrolling interest of $3.4 million.

Then we go on to the outlook for the quarter.

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Alexander Charles Hungate, SATS Ltd. - President, CEO & Executive Director [10]

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Thanks, Shi Yun. Well done. Okay, so now the outlook.

We talked a lot about the weaker cargo volumes due to slowdown in trade and the weak economic growth, and I think our expectation is that will continue, at least for the next couple of quarters. It's hard to predict beyond that. However, despite that, we are committed to growth as we described at Capital Markets Day. If anything, the environment for us to be able to source opportunities has improved because of the downturn, so we are trying to be opportunistic and looking for those opportunities. And as you can see already, even in this difficult environment, SATS continues to generate pretty good revenue growth, which, over time, will start to translate into a stronger bottom line as well.

And that's why we're continuing to invest in enabling infrastructure. So we talked about the new kitchens in China, for example. We're building the supply chain capabilities. The acquisition of Country Foods will help us to accelerate that. We're also putting in the digital supply chain capabilities like warehouse management, transport management systems, et cetera, and ERP. And then the digital control center as I mentioned, the one in KL, which we've started -- which we opened for GTR. And then the implementation of COSYS+ here in Singapore and in China. And of course, the opening of the new ground handling business in China as well. So a lot of investments going on in growth starting to translate in revenue growth, but we expect the environment to remain difficult for the foreseeable future.

Okay. Thanks. Serena, I think we'll start to take questions now, please.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question, we have Ahmad from Nomura.

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Ahmad Maghfur Usman, Nomura Securities Co. Ltd., Research Division - VP [2]

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Just a few questions on my side. When you mentioned that you are able to source more new opportunities because of the downturn, can you probably elaborate more and in which specific regions?

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Alexander Charles Hungate, SATS Ltd. - President, CEO & Executive Director [3]

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Yes. Thanks, Ahmad, for the question. I -- the opportunities that we're sourcing are all in line with what we described at Capital Markets Day. So the top 2 priorities in that strategy were to be the consolidator as we extend our lead in market share for airline catering as well as for ground handling and cargo across the region. So those are the kinds of opportunities that we have in our pipeline. And the valuations of those type of companies are obviously a bit softer in the current environment. So that's why we're trying to be opportunistic.

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Ahmad Maghfur Usman, Nomura Securities Co. Ltd., Research Division - VP [4]

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Okay. So this is more on potential new acquisitions, not so much in terms of securing new customers. Is that what you're saying?

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Alexander Charles Hungate, SATS Ltd. - President, CEO & Executive Director [5]

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That's what I meant in that expression, yes. But of course, we're obviously keen to win new customers as a priority. And you can see that from the data I gave, that we seem to be increasing market share. So I think we are competitive. And a lot of that's because of the investments we've been making in new technologies and -- which have enhanced our services and our effectiveness for our customers.

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Ahmad Maghfur Usman, Nomura Securities Co. Ltd., Research Division - VP [6]

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I see. All right. Okay. The second question, if you refer to Page 9 of the slides. I just want to break down what would be the OpEx breakup between GTR and CFPL of that $35.2 million. Could you probably possibly provide those or at least a rough proportionate breakdown?

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Shi Yun Ang;AVP Group Finance, [7]

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Ahmad, I think you can use quarter 1 GTR number as a proxy to approximate what is the quarter 2 number for GTR in the second quarter, and the remaining balance should relate to Country Food.

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Ahmad Maghfur Usman, Nomura Securities Co. Ltd., Research Division - VP [8]

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Okay, got it. And probably last one. The Page 22 and Page 23, just want to clarify, which one would be the Daxing segment of the associates? Is it number 9?

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Shi Yun Ang;AVP Group Finance, [9]

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Daxing is still in gestational period, so it does not appear in both in the appendix of the shares yet.

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Alexander Charles Hungate, SATS Ltd. - President, CEO & Executive Director [10]

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But timing-wise, the new airport opened on National Day in China, so 1st of October. And that literally was the first flight. So there's virtually no revenue to speak of in the second quarter. But of course, they'll be ramping up all the way through the current quarter.

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Ahmad Maghfur Usman, Nomura Securities Co. Ltd., Research Division - VP [11]

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Okay. So what was the attached cost on -- in the second quarter then with regards to the Daxing operations despite no revenue? I'm sure there's definitely some small costs to it.

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Alexander Charles Hungate, SATS Ltd. - President, CEO & Executive Director [12]

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There are costs, yes. There are costs, especially with the ramp-up. We're not disclosing them, but they're more than $1 million and less than $10 million. So it's kind of in that range.

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Ahmad Maghfur Usman, Nomura Securities Co. Ltd., Research Division - VP [13]

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Okay. And that's on your share or on a 100% basis?

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Alexander Charles Hungate, SATS Ltd. - President, CEO & Executive Director [14]

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So that's our share.

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Operator [15]

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Next, we have Rachael from UBS.

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Rachael Tan, UBS Investment Bank, Research Division - Associate Director & Research Analyst [16]

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I have 2 questions. The first question would be, could you provide the number of ship calls handled for this half year?

And the second question will be, could you take us through the acquisition of the remaining stake in SATS BRF? Because since the JV -- since you've embarked on this partnership, how has your view on this entity changed? And why do you decide to consolidate it, et cetera?

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Alexander Charles Hungate, SATS Ltd. - President, CEO & Executive Director [17]

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Okay, great questions, Rachael. Thanks. The first one, off the top of my head, I think it was 103 ship calls, which is about 10 lower than the same time last year. The reason for that is not because the market for cruise has suddenly softened. There's one particular vessel that was taken out of service to go under maintenance to prepare for the upcoming peak season. So that's a specific, hopefully, nonrepeatable factor in what we think will be an inexorable rise of volume in the cruise business.

The SATS BRF is a great question, so that's a strategy question. When we first did the joint venture with BRF, we had an existing food distribution and trading business in Singapore that we inherited from SFI, when we made the acquisition of SFI. It wasn't particularly high tech and so it didn't use a lot of supply chain-type technologies. And also, it had a market share that is now about -- was about half of what it currently is. So if you look at the market share of the entity after working with BRF for, I guess, more than 3 years or almost 5 years, the market share is considerably higher than it was then. That was the main purpose of working with BRF, which was to, because it was a low-margin business, was to try to combine volumes to get better -- to spread the overheads across a larger volume, and therefore, to try and improve margins. That has been effective. And we now -- so I guess, that mission has been accomplished.

BRF is pulling back from its overseas investments, and therefore, with a willing seller. So we're able to acquire the stake at a very cost-effective price. But at the same time, as you know, from the Capital Markets Day, we are being more aggressive about our investment in food trading and distribution across the region because we think it's one of the levers that we can use to get better returns to scale from all of the purchasing and acquisitions of raw materials that we do between the various kitchens. And having 100% control of that entity actually makes it easier for us to effect that strategy.

Plus, one of the great things that working with BRF has done is it's allowed us to import a lot of very interesting technology for -- to make that business more high tech. And I mentioned some of them earlier like transport management, for example, ERP and warehouse management. So we can now use some of that technology and export from Singapore into the new ventures that we're setting up in China and India to do food trading and distribution, which will cooperate and link back into the food trading hub that we've created with the acquisition of Country Foods.

So I hope that explains that. We think we've made a good value acquisition, but we've also made a strategic acquisition that helps us accelerate time to market for our new digital integrated supply chain across the region.

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Operator [18]

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Next, we have Ajith from UOB Kay Hian.

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K. Ajith, UOB Kay Hian Research Pte Ltd - Director of Asia Transport Research [19]

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I've got 3 -- Alex, I've got 3 questions. Firstly, if you could just share with us in terms of, this is on Slide 21, the reason behind the decline in PATMI for the Greater China segment. Is this -- can I attribute this to Kunshan operations? Or would it be more of the JV and associates? So that's my first question.

Number two is, I noticed there's a significant increase in receivables in this current quarter. Perhaps you could share some light on that? Then perhaps -- I mean good guidance in terms of whether it's from China or some other particular region.

Lastly, you made an announcement on acquisition of Ganzhou SATS or rather setting up for Ganzhou SATS and it seems like you are planning to provide meals or other footfall for the railway operations. Could you perhaps shed some light on that? These are my 3 questions, actually, not 4.

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Alexander Charles Hungate, SATS Ltd. - President, CEO & Executive Director [20]

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Okay. Thanks, Ajith. First of all, the decline in PATMI in Greater China is driven by 2 factors. One is AAT. AAT is our cargo operation in Hong Kong. The

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Operator [21]

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Ajith, please stay on the line. We will connect to the speaker. So bear with us.

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Alexander Charles Hungate, SATS Ltd. - President, CEO & Executive Director [22]

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Okay. Sorry about that, everybody, cut off again. All right. So the 3 questions, Ajith. The first one, the decline in profitability in Greater China, driven by 2 factors. One is the cargo volumes at AAT. So I mentioned earlier that Singapore cargo volumes in the market have dropped about 7%. In Hong Kong, the drop has been much more severe for 2 reasons. I think, obviously, the trade tensions involving China and the U.S. is one, but the disruptions in Hong Kong in general have hit that company. So operating leverage effect is that, that drops down to the bottom line very quickly.

The second reason is a more positive reason in the sense that it's the investment in the Daxing start-up, both for cargo and ground handling and then also for catering. So there have been costs there of starting up. The cost -- the start-up costs in Tianjin so far have been relatively small. So that's not a factor in the current quarter.

Let me take the third question as well, and then I'll leave Shi Yun to talk about the receivables. Yes, you're well spotted. There was an announcement about a new company for SATS in Ganzhou. Now Ganzhou is a medium-sized airport in China. And we intend to -- well, the company's intent is to start a catering venture in that airport. But it's fed from the supply chain and the network of airports that we talked about earlier, the 85 airports. So the capital investment in the new model that we have with supply chain, plus assembly, is lower than a traditional flight kitchen. So the Ganzhou venture will allow us to build a very low-cost, low capital kitchen facility at Ganzhou Airport and feed it throughout our new China supply chain. So that's the nature of that announcement going. Hopefully, it gives you an idea of how well it fits with our strategy based on what we told you at Capital Markets Day.

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Shi Yun Ang;AVP Group Finance, [23]

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Ajith, on the question on receivables, the [basis] is due to the acquisition of Country Foods and where some of them, we have a timing difference in terms of the billing against the last balance sheet.

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K. Ajith, UOB Kay Hian Research Pte Ltd - Director of Asia Transport Research [24]

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Okay. If I may have a follow-up question. This is regarding the India associates. I understand in the previous quarter, there's a loss of Jet Airways contract. But my understanding is that the slots have been filled by other airlines. So if that -- please correct me if I'm wrong, but if that be the case -- or if that is not the case, then is essentially your revenue from TajSATS should have been compensated by the addition of new customers. So please, if you could share some light on that, that will be appreciated.

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Alexander Charles Hungate, SATS Ltd. - President, CEO & Executive Director [25]

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Ajith, thanks. Yes, I mentioned that last quarter, that with Jet dropping out of the market overnight, there would be a gap in the volumes. And you can see that in all of the statistics published by the airports in India. So we talked earlier about Singapore cargo, for example, minus 7%. Hong Kong is probably between minus 10% and minus 15%. India has been around minus 15%. And then passenger volumes also have been -- have dropped, not quite that much, but they've also dropped. And those have not yet fully recovered in the market. So although there are -- the slots are filling up, it's taking a while for the market to fully recover. I said last quarter I thought it would take a few quarters before they were soaked up and the passenger volume reached the same levels again, and that seems to be the case. So some improvements in the Q2, but there's still a gap relative to what existed before the suspension of Jet Airways.

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Operator [26]

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(Operator Instructions) Next, we have Siew Khee from CIMB.

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Siew Khee Lim, CIMB Research - Head of Research for Singapore [27]

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Can I just check on the associates number again. So I get it that you do take time to fill -- backfill the Jet Airways impact. But last quarter, you had a $3 million credit loss. So without that, within that -- but last quarter, you already had some impacts on Jet Airways. But for this quarter, I assume that -- assuming that the impact is the same, but without the credit provisions, wouldn't it be better but -- as you came down? So wanted to check why is that so for Food Solutions' associates?

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Alexander Charles Hungate, SATS Ltd. - President, CEO & Executive Director [28]

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I think what's happened is that you're talking quarter-on-quarter. But of course, there's seasonality involved in the volumes. So the best way of comparing, taking into account the seasonality, is to look year-on-year for each of the 2 quarters, and I think you'll find that the year-on-year drop in this quarter was less than the year-on-year drop for the first quarter. And that's because, as you quite rightly point out, the first quarter has 2 effects. It has both the credit loss and the volume drop, whereas this quarter just has the volume drop. Does that make sense?

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Siew Khee Lim, CIMB Research - Head of Research for Singapore [29]

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Yes, it does. So there's no exceptional weakness in any other associates in the division, the line?

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Shi Yun Ang;AVP Group Finance, [30]

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Siew Khee, I think cargo volume does affect India a bit. So mobile cargo is kind of affected by the cargo volume as well, the Chinese volume.

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Siew Khee Lim, CIMB Research - Head of Research for Singapore [31]

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But this is Food Solutions. So I just want to make sure that the rest of the Food Solutions associates are okay. Nothing considerable that we need to be aware of now?

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Alexander Charles Hungate, SATS Ltd. - President, CEO & Executive Director [32]

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Yes. The big one is TajSATS, you're right. Yes, there's nothing material at the same scale elsewhere, correct.

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Siew Khee Lim, CIMB Research - Head of Research for Singapore [33]

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Okay. And also for Japan increase, you mentioned that you increased capacity in Haneda and then you had new slots as well as new customer. Can you remind us on the capacity that you actually increased? And what is the key reason? I mean, I know all these 3, but what is the #1 reason for 7% and then Q-on-Q increase in Japan revenue?

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Alexander Charles Hungate, SATS Ltd. - President, CEO & Executive Director [34]

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Yes. Some of that is Haneda because some of the slots were already awarded and the flights were mounted. And of course, there's been the Rugby World Cup as well over the last quarter. It won't be quite as significant as the Olympics next year, but there was some incremental passenger volume associated with that.

Haneda, as you know, is an island, and therefore, the space is limited. We took the opportunity -- we think it's a strategic opportunity to expand into adjacent land

(technical difficulty)

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Operator [35]

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Siew Khee, please stay on the line. We will connect to a speaker in a moment.

Ladies and gentlemen, please stay on the line the conference will resume shortly. Please bear with us. Thank you. Once again, please bear with us, we will resume the webcast in a moment. Once again, please stay on the line. The conference will resume shortly. Ladies and gentlemen, please stay on the line. The conference will resume shortly. Please bear with us. Thank you.

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Alexander Charles Hungate, SATS Ltd. - President, CEO & Executive Director [36]

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Hello. Apologies, again. We were cut off. And we think we found a better technical solution. So I hope not to get cut off again.

Just finishing that question about Japan. Yes, so we're already seeing volume growth because new slots have been launched already. There are further slots coming up, though. In April next year, we'll be up to 99,000 slots per annum from the current 60,000 slots. So there's still a lot more growth left in Haneda. So we took the strategic opportunity of acquiring the land next to our current kitchen and expanding.

None of the other caterers have done that and there is a -- there will be a crunch in capacity based on the increase in the flights. So we should be able to soak up the majority of the new growth in Haneda, whereas our competitors will begin to run out of capacity.

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Siew Khee Lim, CIMB Research - Head of Research for Singapore [37]

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Okay. Is your Japan margin improved because of this? Or have you gotten -- okay.

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Alexander Charles Hungate, SATS Ltd. - President, CEO & Executive Director [38]

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Yes. Yes, you can see, I think, in the appendix that both the revenue and the contribution of increase, but the contribution increased faster.

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Siew Khee Lim, CIMB Research - Head of Research for Singapore [39]

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Okay. And also, just a final question on the staff cost. Is there any peculiarity in the staff cost that as it should come down by just -- it's like slight $2 million from last quarter? I know I shouldn't be looking at quarter-to-quarter, but just wanted to understand if there's any special efforts that you have done to keep the staff cost lower than last quarter.

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Alexander Charles Hungate, SATS Ltd. - President, CEO & Executive Director [40]

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Yes. No, that's one where you really have to look year-on-year because different times of the year, as you know, you've got bonuses and other components of the compensation package, yes.

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Siew Khee Lim, CIMB Research - Head of Research for Singapore [41]

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Okay. And also just going back to what you have communicated during the Capital Market Day. Is there any sizable M&A in the near term that we should be expecting? I know you're constantly looking up, but maybe in the next 12 months or so, is there anything that you're seeing that is attractive to you?

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Alexander Charles Hungate, SATS Ltd. - President, CEO & Executive Director [42]

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Well, because we're the market leader in both flight catering and aviation catering, there's no other company in Asia that's of our size. So it's very unlikely that there'll be a massive transformational M&A because those kinds of targets don't exist. However, you can see the kinds of M&A we've been doing. They're small to medium-sized bolt-ons that we can integrate and then add value to, whether they be part of our digital cargo network or part of our digital supply chain network on the food side. And those are -- we're getting quite good at integrating those, and we're comfortable with the pipeline that we have. So we should expect more of the same, actually.

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Siew Khee Lim, CIMB Research - Head of Research for Singapore [43]

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Okay. And so my last question would be your -- a few on the ground on what's going to happen in your business in, say, second half of -- or maybe like from -- during -- all the way through 2020, one of the things that you would be positive on and one of the things that you are worried of. Would Hong Kong be a big worry to you? And would you be like very positive because of Olympics? Some guidance on how you feel the market will be working towards your favor or not favor.

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Alexander Charles Hungate, SATS Ltd. - President, CEO & Executive Director [44]

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Yes, I think that's a fair question to ask. So it's not exactly guidance, but it's our view on what are the upside and downside that we see in the next 12 months. Clearly, cargo is a big one. You've seen how much the reduction in volume has impacted our air freight volume. It is a core part of our strategy to grow our share in that. But obviously, in the down cycle, that does impact our margin. So it's hard to predict beyond the next couple of quarters, how that will play out. So I guess we'll just have to say that we are not optimistic about the next couple of quarters, and I would say, after that. So in the time line you just asked, I guess we have the same questions that you have. It's very hard to predict. It will depend on the geopolitics as well as some of the local trade patterns across ASEAN. But we do think that medium term, driven particularly by e-commerce volumes, we do expect that to continue to increase. So that's an upside for the medium term.

The Olympics will give us some upside in Japan, particularly for the catering business. So that's something that we look forward to. And I think the prospect of soaking up that new capacity that we've built in Haneda will be an upside.

We expect passenger volume to be -- continue to be muted for the next couple of quarters in line with the slowdown economically. But again, we think medium term that, that should pick up again. Hard to predict exactly when that should be. But that's something that we'll both have to start to get comfortable with making our forecast. So we think medium term, let's say, the next 2 years, that will start to pick up again.

One of the things that we do that's relatively immune to the economic cycle is this catering for the fast casual restaurant chains. They seem to be continuing to grow no matter what. And in particular, the consumption of chain food products through food delivery platforms is growing very fast. So that's an area that we expect to continue to grow. And in, as you know, in China, we're already investing specifically against that opportunity and seeing pretty good volume growth. And then in the future, we'll be investing in India as well for that.

I think that's probably a fair summary. Hopefully, it's given you a sense of the upsides and downsides.

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Siew Khee Lim, CIMB Research - Head of Research for Singapore [45]

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Okay. So just my last question. So now we are probably close to 1.5 months into your 3Q. Seasonally or historically, over the past few years, 3Q has always been the strongest quarter. So far, what you have seen, I mean, given what you had mentioned just now, is this still going to be a positive quarter, the strongest quarter for you based on what it had -- what you had done past few years?

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Alexander Charles Hungate, SATS Ltd. - President, CEO & Executive Director [46]

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Yes. Traditionally, this volume is -- the volume in this quarter is the highest of the year, and this year should be no exception. Yesterday was 11/11, which is obviously a huge driver of air freight volumes. And I understand from the press that it was a record for sales. And then, of course, we'll have the holiday season at the end of the year as well. So it is a big quarter and it results in a lot of travel and a lot of air freight, and we expect the third quarter to be our biggest quarter again this year.

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Operator [47]

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Next, we have Ahmad from Nomura.

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Ahmad Maghfur Usman, Nomura Securities Co. Ltd., Research Division - VP [48]

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Just one question. The Air China customer in Daxing, would it involve more than just merely a customer, probably as a strategic shareholder in your view? Or is there something that you're looking towards with?

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Alexander Charles Hungate, SATS Ltd. - President, CEO & Executive Director [49]

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Well, the companies are owned by ourselves and Capital Airport Holdings. So there's no airline partner at this time. Capital Airport Holdings, just to recap for those of you not familiar, is our partner at the Capital Airport itself in the existing catering and ground handling joint venture. So we partnered with them in the Daxing Airport in 2 joint ventures. The ground handling one, we own 40%, they own 60%. And in the catering one, we own 10% and they're the majority shareholder.

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Ahmad Maghfur Usman, Nomura Securities Co. Ltd., Research Division - VP [50]

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But are you looking at a similar format to your existing Beijing one where the airlines are also a shareholder of that asset company?

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Alexander Charles Hungate, SATS Ltd. - President, CEO & Executive Director [51]

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Well, that's not the current structure. If there's any change in the shareholding, we'll obviously announce that.

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Ahmad Maghfur Usman, Nomura Securities Co. Ltd., Research Division - VP [52]

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Okay. So but there's no intention to do so at the moment?

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Alexander Charles Hungate, SATS Ltd. - President, CEO & Executive Director [53]

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I can't really comment because that would be an M&A, so we don't comment on prospective. Yes. Thank you.

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Carolyn Khiu, SATS Ltd. - VP of Public Affairs & Branding [54]

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Now we move on to a couple of questions online. There is one from [Sarah]. The question is, as management invests in central kitchens, where do you see your institutional catering revenue growing in 5 years' time for your top line revenues, excluding associates?

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Alexander Charles Hungate, SATS Ltd. - President, CEO & Executive Director [55]

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Okay, [Sarah]. Yes, this is a good follow-up to the Capital Markets Day because we did say that we intended to invest, in particular, in China, in India to build up the central kitchen that's feeding the demand from chain restaurants and the food delivery market.

What we're doing is we have a plan to build out a series of kitchens in both China, and over time, in India as well. And this will mean that there'll be an increase in the proportion of our food revenue stream from this segment. Right now, the proportion of our food revenue that's non-aviation is only about 20%. So I can see that proportion going up over time. We haven't said exactly what it will go up to because we obviously want to gauge the success of the early kitchen before we decide whether to accelerate or decelerate the rollout program. So I'll refrain from giving you an exact number.

But I will say that the size of that market is substantially larger than the aviation catering market. If you recall some of the market data we gave you at Capital Markets Day, the addressable market for central kitchens, feeding the fast casual restaurant chains in China alone, in China alone, is bigger than the entire aviation catering market in all of Asia. So one way of answering your question is to say that if it becomes very, very successful, over time, probably not in 5 years' time, but over time, it could become as large as the aviation catering business.

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Carolyn Khiu, SATS Ltd. - VP of Public Affairs & Branding [56]

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We have 2 more questions from [Cathy]. One is how is the pricing trend for the food segment, especially in Singapore?

And the other one is in relation with air cargo. He's asking how long do we expect the air cargo down cycle to last (inaudible).

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Alexander Charles Hungate, SATS Ltd. - President, CEO & Executive Director [57]

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Yes. Thanks, [Cathy]. So I guess the food segment has seen a slight downward pricing in the region, and Singapore is no exception. You can calculate it yourself, actually, if you do simple division from some of the volume numbers that we've given you. It's not going down precipitously, but there is a drift down. Some of that's due to de-specking of the meals and some of it's due to price negotiation. Our job is to make sure that our efficiency improvements can offset the price negotiation component. And then obviously, the de-specking component, we're trying to -- we will try to maintain our margins from that. So I think it's -- I would just say it's similar to what we've seen over the last 5 years. So no more intense and no less intense than what we've seen over the last 5 years.

As far as predicting the future trends on the cargo volume, it's very, very difficult to do that. I think so much depends upon the geopolitics as we mentioned last time. And geopolitics, at this point, they are particularly unpredictable. What we are seeing is that from cargo agents, et cetera, and freight forward, is that it does look like the next couple of quarters, things are stabilizing, but not getting any better. So I think that's the best information I can give at this point. Beyond the next couple of quarters, those guys don't really have forward bookings that far ahead, so it's hard to get any insights from them.

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Operator [58]

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Next, we will move on to the audio callers. We have Rachael from UBS.

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Rachael Tan, UBS Investment Bank, Research Division - Associate Director & Research Analyst [59]

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Just a follow-up question on the food distribution side on the non-aviation. Do you have instances where you're starting to see cross-border collaboration of your business units with regard to providing food? Or at this point, are you still actually focused for -- within the country itself?

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Alexander Charles Hungate, SATS Ltd. - President, CEO & Executive Director [60]

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No, good question, Rachael, because that's exactly the intent of setting up the digital integrated supply chain, so we can get more benefit from our scale across the region. If I can give one specific example of a seafood supplier out of Vietnam that was identified, they use sustainable farming methods so we're very interested in working with them. And as we started talking to them about Singapore, we realized that the quality of what they were doing was something that the Japanese TFK business was also interested in. So we're already starting to do shipments from that supplier, not just from Vietnam to Singapore, but from Vietnam to Japan as well.

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Rachael Tan, UBS Investment Bank, Research Division - Associate Director & Research Analyst [61]

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Okay. I guess what -- for a more established vision for this business, do you expect it to be on a 1- to 3-year time line or 3 to 5 years? So if you can get a sense of how the progress is -- how you're progressing on that.

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Alexander Charles Hungate, SATS Ltd. - President, CEO & Executive Director [62]

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Well, I think it will be a journey. I gave that example by way of saying it's already started, which is good. But do I think it could become a lot more comprehensive and all encompassing? Yes, definitely, for 2 reasons. One is our technology that we're putting in place, the team that we're putting in place and the way we're incentivizing them to collaborate with one another, will help. Another reason is because we are increasingly taking control of some of the catering ventures, partly because we know we can add value to them. So as we do that, we'll be able to implement this as part of our post-integration plan.

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Operator [63]

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Next, we have Shaun from Crédit Suisse.

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Shaun Tan, Crédit Suisse AG, Research Division - Analyst [64]

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I have one question on the dividend payout. So payout ratio was around 85% in 2019. So what's your guidance on a sustainable dividend payout ratio for this financial year? And are we likely to see this number go higher, say, above 90%?

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Alexander Charles Hungate, SATS Ltd. - President, CEO & Executive Director [65]

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Okay. Shaun, thanks for the question. Yes, we don't have a payout ratio policy. But what we do say is we want the payout -- the dividend payout to be sustainable. As you know, we are -- at the Capital Markets Day, we did say that we would be investing our capital at a faster rate in order to achieve the strategic objectives that we've set because we think there's a large opportunity for shareholders in the medium term by consolidating our market leadership here in Asia. So we want to make sure that the dividend is sustainable and backed up by the cash flow that the business is generating, but we also want to make sure that there's enough cash available to make sure that the strategy execution can be executed as well. So I think that's all the guidance I can give you rather than talk about a particular payout ratio.

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Operator [66]

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Next, we have Siew Khee from CIMB.

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Siew Khee Lim, CIMB Research - Head of Research for Singapore [67]

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Can I just check on your operating margin? Do you think -- I mean, this quarter, you've done, I think it's quite okay, to 13.1% although it was below last year, but I think I had expected a little bit lower. So you have actually exceeded my expectation. Just wanted to see whether you'll be able to actually reach, or do you have a target of EBIT margin? Maybe it can still reach 13% for the full year or even next year.

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Alexander Charles Hungate, SATS Ltd. - President, CEO & Executive Director [68]

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Thanks, Siew Khee. Thanks for your encouraging words, too, thank you. I would say that the margin for the rest of the year, I'm not going to -- again, I'm not going to give guidance but a lot will depend upon what happens in the cargo. You can see in our first half how much a relatively small drop in cargo can impact our margin overall. Of course, we are making these underlying investments in growth. But if cargo had been doing better on trend, we probably could have absorbed all of those investments and showed a positive margin and result. So the cargo and the environment overall is definitely the overwhelmingly most important factor in the results this first half. If the same thing happens in the second half, then it's difficult to predict an improving margin. So we'll have to just see what happens with the cargo volumes in the marketplace over the next quarter or 2. And then we'll have a better view from the agents and the forwarders and the cargo airlines about how they see the next financial year after that. And obviously, we'll try to share those indications with you as we get them.

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Carolyn Khiu, SATS Ltd. - VP of Public Affairs & Branding [69]

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Okay. We will now move to the last 3 questions from [C. Y.]. The questions are rather long, so bear with me while I read it out.

Recently, your partner, MacroAsia, has acquired a stake in JASCO and I noticed that Gate is hiring an M&A specialist on Asia. Are you seeing more competition that's trying to consolidate the aviation space in Asia? How does SATS differentiate yourselves beyond price during JV or acquisition negotiations with potential targets?

The second question is, if we look at the incremental contribution from GTR and CFPL, the increase in cost exceeds revenue. Can I understand whether the losses are coming mostly from GTR or CFPL?

The last question is, is your investment in growth initiatives the biggest drivers in negative jaws for this quarter? Or are there other reasons driving that? So over to you.

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Alexander Charles Hungate, SATS Ltd. - President, CEO & Executive Director [70]

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Okay. Thanks, [C. Y.]. Let me take 1 and 3, whilst Shi Yun thinks about #2.

Yes. I mean, I think we -- there are -- this is an interesting industry, right? It's -- as SATS demonstrates, it's an industry where you can generate good returns and it's growing fast because of the structural growth of the middle class. So both on the food side and the gateway side, there will always be competitors for acquisition opportunities or partnership opportunities. SATS is one of the companies that will get the first call when those opportunities exist, sometimes on an exclusive basis and sometimes even in a process, more of a kind of an open process where there are multiple bidders. We tend to be differentiated, and let me explain why we're differentiated.

These are activities that for an airline are absolutely critical to their hub operations. So as we've seen in some other situations, which I won't name because they involve competitors and it wouldn't be quite right for me to draw attention to them, but there are situations where somebody's hub can actually be disrupted dramatically by a failure of either their caterer or their ground handler to perform at the highest level. And traditionally, that's why those activities have often been owned by the airline. So now airlines are being forced to really think about what their core businesses are, and they are beginning to spin some of these services off. They will only want to spin them off to partners where they really, really see a tremendous track record of quality. And I think SATS has that reputation of quality. I mean, we -- Changi Airport, best airport in the world. Arguably, Singapore Airlines also, best airline in the world as well, with many, many awards. So our legacy and our history of working with -- in Singapore with those 2 very good, high-quality, world-class brands helps us. But then look at what we've done across Asia. We've got very long-term partnerships with partners in diverse markets from India, Japan, China, et cetera. And those have been successful. A lot of the multinational competitors that come out of Europe and the U.S. have not been able to maintain those kind of partnerships in Asia, maybe because of cultural differences, maybe because of lack of understanding of how the markets work, maybe because in the case of catering, they can't master some of the Asian culinary aspects as well, which is so critical to national airlines when they want to project their national brand authentically. Plus, of course, when you look at our network, we have returned to scale on the catering side, from our supply chain and purchasing, which increasingly we -- based on our strategy on Capital Markets Day, we're trying to exploit even further.

And on the cargo and the ground handling side, we now have more than 60 airports across the region. So we can create a network of services and link them digitally to provide more seamless handling. So we very much differentiate ourselves, not just to our customers, but that differentiation to our customers reflects in the discussions with potential partners as well.

Before I hand over to Shi Yun, let me take the third question, which is, is your investment in growth initiatives the biggest driver in negative jaws for this quarter or are there other reasons? I think there are 2 main drivers. One is our investment in growth initiatives and we talked about how those are taking place across the region. In fact, with some investments we haven't even mentioned on this call, like Saudi Arabia, in the Dammam facility, which is still building out, winning new customers, but still obviously just starting off there, as well as the ones we already talked about in China, Daxing, as well as the non-aviation. Malaysia, where we've been building the cargo facility. So there are a lot of examples where we're making these investments, plus the IT investments we're making in digital, both the supply chain and also cargo. So there is a lot. But the other big impact is the negative jaws is the cargo.

Cargo has, of all of our businesses, probably, maybe with the exception of cruise, of all of our businesses has the most -- has the highest operating leverage. So when you see a drop in revenue suddenly like that, you will see it drop to the bottom line. So operating leverage is high, both on the downside and the upside.

If you look at the relative proportion of those 2 impacts, the larger one is the overall investment. So when you add up all those investments, it does outweigh cargo. But they're not dissimilar in scale. They're in the same order of magnitude. I hope that gives you some helpful indicators.

So Shi Yun, how about the second question?

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Shi Yun Ang;AVP Group Finance, [71]

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[C. Y.], for your second question. I think for the quarter, if you add up GTR and Country Foods' revenue numbers that was given in the slide, you will actually end up at about $36.9 million against the consolidated number for the OpEx cost given of $35.2 million. I think both of them are profitable, but not a loss.

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Carolyn Khiu, SATS Ltd. - VP of Public Affairs & Branding [72]

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Okay. Thank you, Shi Yun. We've come to the end of our session. Thanks, everyone, for coming in today. We speak again in 3 months' time. Have a good evening.

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Operator [73]

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Thank you. Ladies and gentlemen, this concludes today's conference call. Thank you for your participation. You may now disconnect.