Fibre broadband take up shockingly low in Singapore

• Maintain UNDERWEIGHT. The three telcos turned in mixed performances as StarHub disappointed while M1 and SingTel fell in line with expectations. The key events in 1QCY11 were surprise capital management at SingTel and margin compression for the two larger telcos. We remain UNDERWEIGHT on the telco sector in view of cost pressures (albeit not as severe as in 2010) and competition arising out of NGNBN which could lead to multi-year margin erosion. We make no changes to our target prices or earnings forecasts. M1 remains our top pick for having the most upside from NGNBN and the most benefits from soaring inbound visitors. For exposure to regional telcos, we still prefer TM and Axiata.
• Capital-management surprise. Capital management was an unexpected theme in 1QCY11. In addition to a higher-than-expected final DPS, SingTel declared a special DPS of 10cts/share. That said, its capital-management policy will only be reviewed once every three years, to enable SingTel to build up a cash buffer. Meanwhile, there were no surprises from the other two telcos as M1 did not declare any dividends in 1Q while StarHub declared 5cts DPS, in line with its guidance.
• Margins compressed for the two larger telcos. Although margins usually recover in 1Q sequentially, margins for the two larger telcos had weakened this time, albeit for different reasons. StarHub was affected by higher handset subsidies as well as marketing costs as it sought to drive take-up of multi-hubbing service packs. SingTel Singapore also booked weaker margins on the back of mioTV content costs as well as strategic initiatives in new businesses. All in all, this is consistent with our view that Singapore telcos face multi-year EBITDA-margin compression.
• Service revenue weak, as expected. As expected, service revenue shrank 1% qoq but rose 4% yoy. All three telcos recorded weaker mobile revenues qoq due to seasonality.
• Pay-TV subs improved. As StarHub penetrated deeper into the heartlands and targets lower-income groups, it managed to net 4K subscribers, the second consecutive quarter of positive net adds following the loss of BPL rights in Aug 10. Similarly, SingTel managed to add a net 28K pay-TV subscribers as customers were attracted to its pricing and sports content.
• NGNBN take-up low. Despite the launch of NGNBN for the past nine months and with coverage supposedly at 60% of residences and commercial buildings, take-up has been fairly low. We think take-up has been hampered by teething issues relating to rollout, a lack of push factors and little demand for very high speeds. As at end-Feb 11, there were only about 16K fibre subscribers or 2% of the total broadband base.

Review of each telco. SingTel Singapore reported 4QFY11 numbers that saw revenue weakness owing to seasonality although this was made up by higher IT and engineering revenues. EBITDA margins fell 2% pts due to continued pressure from mioTV content costs as well as strategic initiatives in new businesses. StarHub’s 1Q11 disappointed mainly due to lower-than-expected margins arising from: 1) higher handset subsidies as smartphone volumes remained strong; and 2) higher marketing expenditure. EBITDA margins slipped 1.7% pts as a result of this while revenue was fairly flat, leading to a 14% fall in core profit. M1’s revenue was lower due to seasonality and weaker handset sales though its margins recovered on the back of lower handset, leased-circuit and marketing costs.

Valuation and recommendation

Maintain UNDERWEIGHT on the sector, as we remain troubled by cost pressures (albeit less severe than in 2010) and competition from the introduction of NGNBN which could lead to multi-year margin erosion.
M1 still top pick. We remain NEUTRAL on M1 with an unchanged DCF-based target price of S$2.63 (WACC: 8.5%) as it lacks immediate share-price triggers but has the most upside to NGNBN and should benefit from soaring inbound visitors.
We continue to rate StarHub an UNDERPERFORM with an unchanged DCF-based target price of S$2.41 (WACC: 9.7%) on concerns over competition from NGNBN in fixed broadband and pay TV which could add to margin pressure and cross-carriage regulations that could further erode its dominance in pay TV.
SingTel is also an UNDERPERFORM, with an unchanged SOP-based target price of S$3.19. De-rating catalysts are expected from margin pressure in Singapore on content costs and mioTV expansion, rising competition in Australia and lacklustre growth at Telkomsel.