Telecom Sector - OCBC Investment 2016-05-26: Decent start to 2016

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STARHUB LTD CC3.SI  SINGTEL Singapore Telecommunications Z74.SI  M1 LIMITED B2F.SI 

Telecom Sector - Decent start to 2016

• Defensive business & cash-flows
• Dynamics could change; but not majorly
• Yields are still important

Decent start to 2016

• The three telcos made a pretty decent start to 2016, with both Singtel and StarHub posting results that were within our expectations; but M1 was just slightly softer-than-expected. 
• Nevertheless, this is still noteworthy, given the spate of 1Q earnings disappointments across a broad swathe of sectors.

Outlook for 2016 largely “stable”

• Going forward, M1 and StarHub has guided for a mostly “stable” outlook in 2016, which does not come as any surprise, given the more cautious economic outlook; excluding the expected spectrum payments due in 3Q16, the two telcos expect to spend around S$140m and 13% of total revenue, respectively, on capex. 
• Singtel has guided for both consolidated revenue and EBITDA for the group to grow by low single digits, with its Singapore consumer business likely to remain stable. It, however, will be spending around S$2.8b on capex (S$1b for Singapore).

ARPUs hit by lower roaming revenue

• The three telcos cumulatively added another 38k new post-paid subscribers, or +0.8% QoQ to 4880k subscribers; proportion of 4G users has risen to around 76% of the total. We note that is also consistently with the portion of post-paid subscribers on tiered plans, with Singtel leading the pack at 92%, followed by M1 (75%) and StarHub (65%).
• However, monthly ARPUs were all lower in the quarter, with the telcos citing lower roaming revenue (both inbound and outbound) as the reason for the drop. But as more travelers switch to OTT (over-the-top) services, the continued drop in roaming revenue could be a concern; this as roaming revenue can make up as much as 20-25% of overall mobile revenue for the telcos.

But data usage still on the rise

• On the other hand, the three telcos noted that data usage is still on the rise, with M1 noting that its average post-paid smartphone data usage has increased to 3.3GB per month in 1Q16, up from 3.2GB in 1Q15. 
• While the telcos are keen to monetize the increased data usage, the percentage of tiered-plan subscribers who exceed their data bundles remain low around 20-23% across the telcos.

Telcos remain hopeful data usage will drive growth

• Nevertheless, the telcos are largely hopeful that the rising data usage will continue to drive growth. Some of the measures put in place include allowing subscribers to use their local data bundles overseas for a small fee. Telcos are also encouraging their subscribers to “trade up” to the next price plan with a bigger data bundle; although the telcos will make “less” from the excess data charges, they gain earnings stability by swapping “ad hoc” revenue (collectable only when customers exceed their data bundles) for more certain recurring income.
• Indeed, this is how the incumbents view the recent move to offer “upsized” data for an additional S$6/month, with some of them effectively doubling the data bundles under certain price plans. Recall in Mar the three telcos started to offer these data options on their plans after MyRepublic (MR) – one of 4th telco hopeful – gave a glimpse of how its price plans would look like should it win a license.

No reaction to new MNVO

• On the other hand, we did not see much, if any, reaction from the three incumbents when MVNO (Mobile Virtual Network Operator) Circles.Life launched its mobile services recently through a leasing agreement with M1. One possible reason is that Circles.Life is offering pricing plans pretty similar to what the current incumbents are offering. 
• In any case, Circles.Life is not the first MVNO here – Virgin Mobile tried to offer mobile services as a MVNO in 2001 by leasing network from Singtel but folded after a year.

Eyes remain on potential 4th telco

• Instead, we believe that the three telcos are saving their „bullets‟ for the potential entry of a 4th telco; recall that the IDA has set aside a block of 4G spectrum at a special reserve price for a new operator at the upcoming auction in 3Q16. 
• In our view, a new physical operator will probably have more disruptive impact on the market; so far, we have already seen a round of “price cuts” from the incumbents. But as before, the new entrant would need pretty deep pockets to achieve the roll-out and coverage target set by the IDA; and it would be a challenge to wrestle meaningful market share away from the incumbents. 
• Nevertheless, MR believes that it is confident of achieving break-even within three years of securing a license, even with a relatively small user base.

APRUs are stabilizing; focus on higher speeds

• Residential broadband market remains fairly stable, where the three telcos had managed to add a total of 7k new customers; and the three of them have cornered about 89% of the overall market in 1Q16, up slightly from 88% in 4Q15. Again, the ability to bundle may be helping the incumbents to further increase “stickiness”.
• Also encouraging is the fact that monthly ARPUS are not only stabilizing as a whole, but is starting to show a slight uptick (for M1 and StarHub); this as the competition has shifted towards offering higher speeds at the same price points rather than pushing the cheaper price plans to gain market share. We note that StarHub has also been able to add value to its offering with its “dual” broadband, which comes with both fiber and cable connections, at a higher price point.
• On the other hand, ARPUs could start stagnating again once the bulk of the subscribers are on the 1Gbps plan, which is more than sufficient for the needs of most users. While some RSPs have started to offer 10Gbps plans, we do not expect them to become mainstream anytime soon, given the lack of affordable consumer hardware and more importantly, the lack of a “killer app” that could utilize such high speeds.

Pay TV market likely peaked

• Since total Pay TV subscribers hit 968k in 1Q15, the market has been seeing a decline and in the recent quarters, the decline appears to have picked up speed – the Pay TV segment lost some 9k subscribers in 1Q16, almost doubled the loss of 5k in 4Q15. 
• The bulk of the losses came from StarHub (-8k subscribers), which management attributed it to the company stopping the promotion for TV Lite. But we think that the decline could still continue, given that Netflix has only just launched the Singapore service in 1Q16.

Not likely to completely cut the cord

• Having said that, we do not expect Pay TV viewers here to completely cut the cord for several reasons. 
• For one, Pay TV customers will continue to pay for regional content, given the diversity of viewers here. 
• Secondly, there is a lack of “live” sports content on Netflix like EPL etc. 
• Thirdly, the Pay TV operators here tend to carry the most current content and the latest episode of popular series, with viewers getting to watch the latest episode less than 24 hours of it being aired in the US. 
• Last but not least, the two Pay TV operators are also joining in the OTT fray with their own mobile TV apps, which currently offer a not insignificant advantage – subscribers are not charged for mobile data consumed while watching on the go.

Increased odds of a Jun Fed hike

• According to the latest minutes from the Apr FOMC Meeting just released on 18 May, the Fed officials were more inclined towards a rate hike in Jun, citing signs that the US economic growth was picking up in 2Q and that employment and inflation were firming. 
• Market watchers note that futures prices suggest that the odds of seeing a rate hike have risen to 34% from just 19% just before the release of the minutes. However, some market watchers are not entirely convinced that the Fed will go ahead with a hike in Jun, much less room for more than one rate hike this year.

Singapore interest rates still pretty low

• In fact, the local interest rates have only risen very modestly on the back of the news, with the near-end edging up several basis points, while the longer-end appears to remain pretty flat. If anything, the yield curve continues to leaning closer to the low than the average over the past one year. 
• Specifically, concerns over slowing economic growth here are more likely to be the over-riding factor here; and MAS has previously said that it will not allow the SGD to appreciate, suggesting that there may not be a corresponding hike in Singapore interest rates.

Focus still on dividend yields

• No doubt the news of an impending US rate hike could spook the market, especially “yield plays” like the telcos, but we believe that pullbacks should be seen as potential opportunities to pick up these defensive counters. 
• In addition, the telcos are not highly geared and any jump in interest rates would also not affect their profitability much. 
• More importantly, we believe that their strong free cash-flow generation should also sustain their dividend payouts over the medium term.

Maintain OVERWEIGHT

• Amid a more uncertainty economic environment, we believe that investors could continue to seek out these companies, not only for the defensive businesses, but also their stable dividend payout policies. Hence, we maintain our OVERWEIGHT rating on the sector; but we are mindful of the ongoing challenges in the sector, not only in the mobile segment, but also the Pay TV segment for both Singtel and StarHub. 
• For now, Singtel (BUY, S$4.09 FV) remains our top pick.

OIR Recommendation

Carey Wong OCBC Securities | http://www.ocbcresearch.com/ 2016-05-26

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