Decent dividend: Telcos a ‘safe refuge’ with a stable 7% yield

We are upgrading the telco sector to OVERWEIGHT (from Neutral) as we believe it is time to re-visit the relative safety of telcos amid market turmoil and as we turn more bearish on the market. Telcos offer fairly stable earnings and attractive dividend yields of about 7% which are backed by FCFE yields of 6-8% and fairly low net debt/EBITDA. Mobile competition is easing while the threat from
NGNBN is less than expected.

We upgrade StarHub to OUTPERFORM from Neutral with an unchanged target price of S$3.03 on stabilising margins and slowerthan- expected competition from NGNBN. Likely re-rating catalysts are economic uncertainties and dividend announcements. We also upgrade SingTel to OUTPERFORM from Neutral because of its recent de-rating and an improving outlook for its key units. M1 remains a NEUTRAL as it lacks catalysts but downside should be supported by its attractive yields of 6-7%.

• All about cash. Telcos offer a safe refuge given their attractive and stable yields of 7%. The dividends are backed by higher free cash flow to equity (FCFE), except for StarHub. With net debt/EBITDA ratios below 1.1x, the balance sheets of all three telcos are strong and track below their thresholds. Their balance sheets also allow for capital management although such prospects are tempered by an uncertain global economic environment.

• Mobile competition is easing. Competition is easing in the mobile industry where margins had improved qoq in 2Q11 after seven quarters of declines as operators pulled back on their aggression. Also, voice RPMs are stable. The industry went though a structural shift to lower margins from the introduction of mobile number portability and higher subscriber acquisition/retention costs given the surging popularity of high-priced smartphones.

With smartphone penetration among postpaid users now reaching 65-70%, we think the worst of margin pressures is over. However, year-end festivities and the expected launch of the iPhone 5 in 4Q could stir the pot again though this should be seasonal rather than structural given the already-high penetration of smartphones, in our view.

• Fixed broadband stabilising. The threat of competition in fixed broadband, which has long been a source of concern to us, has dissipated. Fixed broadband ARPUs have stabilised while revenue is on an uptrend after lower-priced plans have worked their way though the customer base. NGNBN is less of a threat than previously thought given the low percentage of homes connected and the need for very high speeds.

• Risks. Key risks to our calls are a more competitive environment, margin pressure, investors’ shifting preference for cyclicals once economies stabilise, any further erosion in fixed broadband/pay TV and in the longer term, the ongoing substitution of voice by data and slowing population growth.