Telecommunications Sector - UOB Kay Hian 2015-09-04: Assessing Risk-Reward Balance.

Telecommunications Sector

Assessing Risk-Reward Balance 

  • Telcos provide a defensive shelter to investors and valuations are more palatable now after the recent share price corrections. The downside from a reversal of yield compression has reduced significantly. 
  • Yield spreads and free cash flow yields have become more attractive. 
  • Maintain BUY on our top pick Singtel. Maintain MARKET WEIGHT. 


WHAT’S NEW 


 Telco sector is a defensive shelter. 

  • Telcos are sturdy defensive stocks because demand for telecommunications services, being a basic necessity, is inelastic. Telcos in Singapore also have low gearing levels based on net debt/EBITDA. According to Bloomberg, the beta is 0.61 for M1, 0.59 for StarHub and 0.82 for Singtel. 

 Downside from reversal of yield compression has moderated. 

  • Yield spreads for Singtel and M1 have expanded after the recent corrections and are now above their longterm means of 3.24% and 0.96% respectively. The downside for M1 and StarHub in the event that yield spreads revert to their long-term means has been reduced from 20% to the current 10%. M1 and StarHub’s maximum downside in the event that yield spreads expand simultaneously with a hike in 10-year government bond has been reduced from 30% to 15%. 

 Current valuations inflated by yield compression. 

  • We analysed peak and trough valuations from the last three market cycles, namely those which took place during the outbreak of SARS, the Global Financial Crisis and the European Debt Crisis. Singtel offers the best risk-reward trade-off. It has the highest average upside of 21.5% and the lowest average downside of 31.6% based on EV/EBITDA. 

ACTION 


 Be selective. 

  • We started the year with many investors being complacent on the impact from the potential entry of a fourth mobile operator. The correction of 27.3% for M1 and 17.7% for StarHub from their recent peaks has skimmed the froth in share prices. 
  • Singtel is our top pick. We maintain HOLD for M1 and StarHub. 

M1 (HOLD/S$2.90/Target: S$3.08) 

  • M1 provides an attractive free cash flow yield of 6.4%, which is higher compared to 5.1% for StarHub and 5% for Singtel. Its yield spread has also recovered to 3.8%. Entry price: S$2.80. 

StarHub (HOLD/S$3.56/Target: S$3.57) 

  • Bundling multiple services allows Starhub to hold a more resilient customer base that is less likely to be poached by competing mobile operators. However, the correction in its share price is less severe and yield spread is below its long-term mean. Entry price: S$3.20. 

Singtel (BUY/S$3.70/Target: S$4.72) 

  • Singtel benefitted from the growth of its regional mobile associates Telkomsel, Bharti Airtel, Advanced Info Service and Globe Telecom. 


SECTOR CATALYSTS 

  • Investors buying into telcos as a defensive shelter. 
  • Dividend yields have recovered after share price corrections. 


ASSUMPTION CHANGES 

  • We maintain our earnings forecasts and target prices. 


RISKS 

  • Entry of a fourth mobile operator that uses low pricing to win market share.



Jonathan Koh CFA | http://research.uobkayhian.com/ UOB KH 2015-09-04
BUY Maintain BUY 4.72 Same 4.72
HOLD Maintain HOLD 3.08 Same 3.08
HOLD Maintain HOLD 3.57 Same 3.57


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