Description

*Vietnam wasn't an option in the drop-down box so I listed it as Thailand - to be clear this is a Vietnamese company listed in Vietnam

A. Investment Summary

• SCS is one of two cargo support operators in Tan Son Nhat airport (only international airport in HCMC)
• Long runway for growth: In the duopoly market, SCS has 36% market share of cargo throughput while Tan Son Nhat Cargo Service (TCS) has 64% - TCS is operating at maximum capacity and has no land to expand (SCS owns 14.3 hectares of land around it) thus SCS will get all of incremental cargo volumes
• Growing aviation market: One of the fastest growing aviation markets in the world (10-year CAGR of 17.4%) driven by rise in domestic & foreign travelers and low cost carriers. Freight is expected to grow faster than passenger growth
• Operating leverage:Most of their costs are fixed, management is targeting 70%+ EBIT margin for operations in Tan Son Nhat airport from FY19 onwards - already achieved 69.9% EBIT margin for 1H18
• FCF generative - good quality of earnings, consistently higher than net income: FCF > Net Income for the past 4 years, company has been actively paying down debt every year from VND 373bn (US$16.1mm) in FY14 to VND 10bn (~US$0.4mm) in FY17, paid off everything in 1H18 results. Company has also been returning cash to shareholders through dividends, paying out 75% of net income in FY17 (2.9% div yield)
• Under-followed as recently listed on HOSE: Only 1 analyst covering the company + just listed on Vietnam's main exchange on August 3 so it doesn't show up on screens. English annual report was only sent to us after I showed him the link to English financial reports was not working did he send it to us through email (he said he would upload the English versions on their website soon after he realised his mistake)
• Valuation: On a DCF basis, undervalued given its ability to get high returns on capital and strong cash generation of 5-9% FCF yield going forward. Using peer valuation, the most relevant in the region is SATS (SGX:S58) as they operate in a duopoly market in Singapore with Dnata. SATS has lower margins, growth prospects, FCF yield and ROCE compared to SCS yet trades at 15-27x P/E and 13-25x EV/EBIT depending on the cycle from 2009-2018 (now its trading near the top).
• Key Risks: i) Management guided that they will be looking to do acquisitions related to aviation with all the cash they generate, so far SCS doesn't have any track record of making good investments, ii) 14.3 hectares of land where their terminal is built is leased from the army for 49 years, starting from 2008 and will end in 2057, iii) Increased competition and/or unfavourable operating terms in the new HCMC airport scheduled to be completed in 2025

B. History

• SCS was established 10 years ago in 2008 by 4 major shareholders: Gemadept (largest private port and logistics operator), ACV (owner of all commercial airports), the Army and Asia Commercial Bank (largest private bank by assets which has mostly exited by 2018)
• They invited Lufthansa to be their concept consultant, Coteccons to be their contractor and a Japanese airport consultant to help design the terminal in Tan Son airport
• German supplier, Lodige, was appointed to provide equipment and operational know-how, construction took 2 years and they started operations at the end of 2010

C. Macro environment: Rise of low cost carriers coupled and increasing travelers = Strong tailwinds for growth in cargo volumes

• Passenger growth: As one of the fastest growing aviation markets in the world with a 10-year CAGR of 17.4%, Vietnam is expected to continue its strong trajectory (16% annual growth from 2017-2020, 8% from 2020-2030)
• Cargo growth: According to Civil Aviation Administration of Vietnam (CCAV), freight transportation is on track to outpace passenger growth with a forecast growth of 12.8% until 2020, and 15% thereafter until 2030

• Air freight volume has been seeing remarkable growth from 0.5mm tons in 2010 to 0.96mm tons in 2015. This figure is projected to be 1.8mm tons in 2020 and 7.3mm tons by 2030
• For comparison, Singapore which has 1/13th the population of Vietnam handled 2.1mm tons in 2017. While average GDP is higher, Singapore is not a manufacturing hub unlike Vietnam, thus the target of 7.3mm tons in 2030 does not seem too far-fetched
• International passengers - 7th fastest growing tourist attraction: In June 2017, Telegraph ranked Vietnam as the 7th fastest growing travel destination, with a 24.6% yoy growth in tourists as the country becomes modernized + more accessible for foreigners
• Domestic passengers: As the country becomes wealthier and more budget airlines are available (Vietnam Airlines, Vietjet, Jetstar Pacific, Vietstar Airlines and SkyViet), flying is becoming a more viable option for a domestic traveler
• Other drivers - low labour cost & FDI inflows: FDI inflows coupled with competitive labour wages make Vietnam an attractive hub for manufacturing. With ~1/3 the labour cost of China, even some Chinese firms have been outsourcing to Vietnam.
• An interesting piece of information is that Samsung is extremely important to Vietnam. It is estimated that Samsung accounts for 20-25% of Vietnam's total exports! Another firm with large operations in Vietnam is LG Electronics
• Globally, in 2017 air freight accounts for only 0.3% of global trade by volume but represents 33.9% of global trade by value. Surprisingly, although air is the fastest mode of transport, a survey conducted by IATA revealed that consumers are choosing air due to its reliability and predictability. Therefore, cargo handlers with technology that allow parcel traceability will be a huge advantage - something that only SCS can offer, at least in Tan Son airport

D. Business

• 4 operating segments: i) Operating cargo terminal, ii) Leasing airport parking (mostly to one of its parent companies, Airport Corporation of Vietnam), iii) Leasing office buildings, football field and parking, iv) Others (vocational training and agent for petroleum trading)
• The key segment is of course its cargo terminal which has grown its contribution from 85% to 92% of overall revenue. This segment includes a number of principal businesses - i) Providing forwarding service, ii) Loading and unloading service, iii) Aviation ground services, iii) Providing storage service, iv) Transportation of goods, v) Customs clearing agent
• Customers are primarily airlines: For the cargo terminal, their customers are the airlines for baggage and importers/exporters for goods. As of July 2018, MD said they work with 24 airlines, up from 3 in 2010, with the largest being Vietjet followed by Emirates
• Contracts: A concern that we had was whether they were regulated by ACV in their pricing. According to the MD, the handling charge is negotiated and agreed by the carriers, independent of ACV or the Army
• Margin expansion as majority of costs are fixed: Gross profit margin for cargo terminal has grown steadily from 65.4% in FY14 to 77.3% in FY17 as most of the COGS associated to the terminal is fixed (actually decreased from VND 124bn in FY16 to VND 123bn in FY17). Furthermore, many of the G&A expenses are also relatively stable like depreciation and utility expenses. Main variable costs are employee salary, office stationary and other external services rendered
• Tax benefit: Given as an incentive to provide cargo handling services, SCS was given a 50% reduction of tax expenses for 9 years starting from 2015, hence their preferential ETR of only 10% (I assumed 20% tax from 2024 onwards in my model)

E. Capex requirement

• Tan Son Nhat Airport
  • With their current terminal, SCS's maximum capacity is 200k tons, of which they used 143k tons in FY17 (71.5% utilisation) - maintenance will be ~US$0.5mm per year
  • Plan to expand capacity by 150k tons (total of 350k) over the next 2 years at a total cost of US$7-10mm (~VND 230bn)
• Long Thanh Airport - New HCMC airport scheduled to open in 2025
  • Still long way more, management only expects construction for new cargo terminal to start in 2023
  • Proposed cargo terminal will have capacity of 500k tons and will cost US$80-100mm (~VND 1800-2300bn) to complete

F. Competitive advantages

• Land - Their strongest and most unassailable moat is their 14.3 hectares of land, breakdown:
  • Cargo terminal: SCS uses 2.67 hectares while TCS has ~5 hectares which are fully developed, running at maximum capacity and no land around for them to expand
  • Apron (tarmac): 5.2 hectares that can fit 3 wide Boeing planes or 5 narrow Airbus planes simultaneously - This is rented to ACV at a very low fee and contribute to ~1% of total revenue
  • Offices, parking and football field: These 3 facilities take up 6.4 hectares but there are 13 small football fields which SCS plans to remove to either construct a new office building for rental or expand their cargo terminal
• Technology - SCS' cargo terminal was constructed 16 years after TCS and employed both German and Japanese experts for consultation. SCS also used Lodige's equipment (which does look quite impressive on their website). Putting it together, their terminal has 54 elevated ground docks, making other equipment like forklifts to load/unload trucks redundant, thus reducing labour costs. Their terminal is equipped with 4 modern x-ray scanners and 1 Smith Detection unit (pictured above) to ensure minimal disruption to the entire process without sacrificing security
• Facilities - They own the only terminal in Tan Son Airport that offers cold storage facilities suitable for frozen or perishable goods, giving them even more pricing power
• Major shareholders - While not ideal, SCS operates in a frontier market thus it is of utmost importance to receive backing from the Army and ACV. With both being shareholders, the management is confident that they will get a favourable deal to operate at the new HCMC airport from 2025 onwards

G. M&A Opportunities

• From all the cash that the company generates, management has said that they might seek new opportunities through acquisitions in aviation-related businesses because they are certain this sector will continue to have strong growth both through passengers and more cargo space in planes
• Strategy: Not clear cut yet but will only invest in things where they can bring their expertise
• Goal: They admire SATS in Singapore and aim to be the Vietnam equivalent, and might go into food solutions - lower margins but very big market. For comparison, SATS is a US$4.3bn company that generated sales of US$1.3bn in FY18 with 55% from food and 45% from gateway services (cargo handling grouped here) vs SCS total sales of ~US$25mm (less than 2% of SATS sales)

H. Valuation

• Revenue: Using moderate assumptions (wouldn't say conservative but certainly below management's guidance) of 13% revenue growth for 5 years followed by a gradual decrease to 1% over the subsequent 8 years, reaching VND 2,194bn in FY30
• Based on today's rate per ton, it would take 530k tons to achieve VND 2,194bn when SCS would have 850k ton capacity. Even if they have to lower their prices for the new airport due to higher competition, they have a fair amount of liberty (~320k tons)
• Margins: Normalised EBIT margin of 67% - I expect a decline in EBITDA margin once operations in new airport starts but lower D&A expense as % of sales because capex will be completed by then
• Capex: i) Expansion for current terminal - VND 230bn (~US$10mm) over 2018 and 2019, ii) Terminal for new airport - VND 2,110bn (US$91mm) over 4 years, 2023 to 2026
• Tax rate: 12% from 2018 till 2023, 20% from 2024 onwards once their 50% reduction in tax benefit ends
• Based on my assumptions, we have a 49% upside which could be considerably more if we use management's targeted margins of 82%+ EBITDA margin and a higher growth rate

• On a longer-term basis, if SCS is able to transform itself into the SATS of Vietnam, the company could potentially be worth multiples of its current valuation. Of course there is less competition and uncertainty in Singapore (only 1 commercial airport and 2 cargo players), but Vietnam is a much larger country with 13x the population and more promising demographics (young population + rising GDP = higher imports, more manufacturing = higher exports)

I. Risks

• Regulatory risk: Currently, SCS is able to negotiate independently with carriers on their prices but there is always a risk that the government/army might step in seeing their abnormally high margins. Additionally, their land lease will expire in 2057 and there is no guarantee that they will get an extension
• Increased competition: Nothing is confirmed about the new airport at this time. While management is confident that SCS will get a good location & deal to operate because their shareholder, ACV, will run the airport, their margins could be much lower due to lower bargaining power + higher A&P spend (don't have to spend to attract customers in Tan Son airport as they are the only one with available capacity)
• Macro downturn: Air cargo volumes are quite linked to the macro economy, in a downturn there will be less trade and travel
• Acquisitions that destroy value: Although the strategy is sound, management does not have a proven track record of making investments (good or bad) - we will have to monitor their acquisitions closely
• Capex cost overrun: Unavoidable risk, but I will track the capex spend for phase 2 of current cargo terminal and reevaluate my assumptions if there is a big discrepancy between actual spend and what management guided

Catalyst

• Greater travel 
• E-commerce growth / air cargo growth
• Good acquisitions