NetLink NBN Trust - DBS Research 2017-11-10: Business Trust With Ample Debt Headroom

SGinvestors.io

NETLINK NBN TRUST CJLU.SI

NetLink NBN Trust - Business Trust With Ample Debt Headroom

• NetLink NBN Trust's 2Q18 results largely in line with expectations.
• End-user connections ahead of targets, on track to achieve targeted end-user connections by year-end. 
• Look forward to supporting fourth mobile telco for mobile network backhaul.
• Current yield 5.6% (FY19F); Maintain BUY, TP S$0.95.

Sole nationwide provider of residential fibre network in Singapore. 

• We argue that NetLink NBN Trust (NLT) should trade at FY19F yield of 4.9% (versus 5.6% now) reflecting lower earnings volatility, longer asset life and ample debt-headroom for future growth. 
• NLT’s assets are mainly underground passive infrastructure (ducts, manholes and fibre) with long asset life while business environment is also less volatile as 92% of the business is regulated in nature. 
• Projected FY19F total debt-toEBITDA ratio of 3.2x is much lower than 5.3x average for Business Trusts in Singapore/Hong Kong, implying room for higher growth by optimising its capital structure.

Where we differ: 

• We believe the market is concerned that rising interest rates may lead to a search for higher yields in the long term. NLT has hedged its interest rates till March 2021 and growth in distributions (4.6% CAGR over FY18-20F) should translate into higher distribution yields. 
• One unique advantage of NLT over REITs and Business Trusts is that any potential rise in the cost of capital would possibly lead to higher regulated returns (versus Regulated Asset Base (RAB) pre-tax WACC of 7% now) from 2022 onwards, translating into higher distributions.

Potential catalysts:

1. Newsflow on TPG Telecom’s backhaul rollout leveraging on NLT’s infrastructure in early 2018, and
2. Widened scope of Smart Nation initiatives as NLT could use its debt headroom to invest in those initiatives, leading to a healthy growth in distributions in the long term.

Valuation

Maintain BUY, TP of S$0.95. 

• We arrive at our target price of S$0.95, representing a ~15% upside from current prices, using WACC of 5.7% (Rf 2.5%, Beta 0.55, Cost of equity 6.4%, Cost of debt 4.0%) and terminal growth of 1.2% to reflect the long-term household formation rate.

Key Risks to Our View

• Key risks to our view will be regulatory changes. As ~80% of the revenue is regulated under the RAB model, any changes in nominal pre-tax WACC from 2022 onwards may lead to changes in Interconnection Offer (ICO) pricing.

WHAT’S NEW

2Q18 results largely in line with expectations (Note: For the period 19 Jun 2017 to 30 Sep 2017) 

• NLT’s results for the period was largely in line with our expectations, with slight variation from NLT’s forecasts disclosed in the Prospectus. 
• Revenue at S$64.8m was 1.2% lower than NLT’s forecast due to lower installation revenue for fibre termination points in residential homes as rate of migration by non-fibre subscribers to fibre was slower than expected for the period. 
• For the period, EBITDA, PBT, NPAT were higher than forecast due to lower operation and maintenance costs, which arose from timing as well as lower-than-expected costs for outsourced contractors, as well as staff costs. EBITDA margin came in at 72.2% for the period, compared to our assumptions of 70.3% for the full year and we believe costs will normalise over the next 2 quarters.

Higher monthly recurring connection revenues. 

• We note that installation revenue is one-off and this was offset partially by higher monthly recurring Residential and Non-Residential connection revenue than forecast due to subscription numbers tracking ahead of NLT’s forecasts as of 30 Sep 2017.
• As of 30 Sep 2017, NLT has 1.14m residential connections and 42,028 non-residential connections, compared with its target and our assumptions of 1.18m and 42.8m nonresidential connections.

On track to achieve target end-user connections: 

• While the residential migration rate was slower than expected for the period, we note that Retail Service Providers (RSPs) are actively promoting the bundling of their suite of services, including fibre connections, to their customers. Our cross-checks with Telcos have also indicated that Telcos are actively promoting migration to fibre connections. 
• NLT’s latest Central Office at Hougang is poised to provide residential fibre connections to new housing estates in Sengkang and Punggol. We believe NLT is on track to achieve its target end-user connections for FY18.

Outlook and recommendation 

Look forward to supporting fourth telco, TPG: 

• As TPG ramps up on its operations locally in 2018, we expect NLT to benefit from supporting TPG in its mobile network backhaul deployment. According to NLT, they have received NBAP connection orders from TPG and is also leasing space to TPG in the central office.

Smart Nation initiatives: 

• NLT is seeing more activities in this space and is actively talking to various government agencies, as GovTech embarks on a Digital Government Transformation.

Planning for the future: 

• New homes add to NLT’s pipeline for new residential fibre connections. NLT has begun to plan the expansion of its network under the universal service obligation to serve upcoming new townships, for instance, the Tengah estate, which could comprise up to 42,000 new homes over the next two decades.

Maintain BUY, TP of S$0.95. 

• We continue to like NLT as a defensive yield counter, offering 5.6% yield (FY19F) at current prices. 
• We arrive at our TP of S$0.54 using WACC of 5.7% (Rf 2.5%, Beta 0.55, Cost of equity 6.4%, Cost of debt 4.0%) and terminal growth of 1.2% to reflect the long-term household formation rate.

Sachin MITTAL DBS Vickers | Singapore Research DBS Vickers | http://www.dbsvickers.com/ 2017-11-10

DBS Vickers SGX Stock Analyst Report BUY Maintain BUY 0.950 Same 0.950