Telecom Sector - OCBC Investment 2017-11-23: Muted Outlook As Space Gets Crowded

Telecom Sector - OCBC Investment 2017-11-23: Muted Outlook As Space Gets Crowded Singapore Telecom Sector Review of SingTel vs M1 vs StarHub SINGTEL Z74.SI STARHUB LTD CC3.SI M1 LIMITED B2F.SI

Telecom Sector - Muted Outlook As Space Gets Crowded

  • Mobile industry under pressure.
  • Singtel our sector top pick.
  • Not all are ripe for picking.

1) Sector Recap 

3QCY17 financial performance recap 

  • All three telecommunications service providers (telcos) reported decline in earnings with each one impacted by different reasons. 
    • For Singtel, it was mainly due to weaker performance from its associate, Airtel, amid intense competition in India. Singtel’s 2QFY18 (3QCY17) EBITDA was boosted by improvements at its consumer and digital life segments but partly offset by enterprise segment due to change in business mix towards the lower margins ICT-related businesses. 
    • For Starhub, while its enterprise business started to gain traction, 3Q17 PATMI came in lower YoY as it was eroded by weaker revenue contributions from mobile, pay TV and broadband businesses. 
    • For M1, decline in 3Q17 bottom-line was mainly driven by weaker handset sales due to timing of launch of key smartphone models, as well as lower international call services revenue given the increasing adoption of over-the-top (OTT) services.

Unexciting outlook 

  • For Singtel (FYE 31 Mar), it reaffirmed its FY18 guidance for group revenue to grow by mid-single digit level and EBITDA to grow by low single-digit level. Mobile service revenue from Australia is expected to grow by low single-digit, but Singapore’s mobile revenue is expected to decline by low single-digit. Group ICT revenue is guided to increase by mid-single digit, which includes cybersecurity revenue of S$550mS$650m. Singtel guided for capex to be: S$2.6b on an accrual basis and S$2.4b on a cash basis. Guidance on ordinary dividends from regional mobile associates remained at S$1.4b for FY18.
  • Starhub guided for FY17 service revenue to be flat and service EBITDA margin to be between 26% and 28%. Dividend guidance is maintained at S$0.04/quarter for FY17. However, it lowered its capex guidance to 10% (previously 13%) of total revenue, excluding spectrum payments.
  • For M1, it continued to guide for a decline in FY17 NPAT but maintained its dividend payout ratio guidance of 80% for FY17. It also guided for capex to be S$150m for FY17, which excludes any spectrum payments.

Still underperforming the broader market 

  • Since the start of CY17, the Singapore telecom sector, represented by FTSE Straits Times Telecommunications Index (FSTTC), has been tracking the STI index’s performance closely until Mar 17, when FSTTC started to diverge, and has since been underperforming STI Index. 
  • In our view, this underperformance is due to the intensifying competitive landscape with the impending entry of TPG, aggressive marketing by mobile virtual network operator (MVNO), Circles.Life, as well as MyRepublic’s intention to become the second MVNO in Singapore, albeit behind its publicly announced schedule of Oct 17. 
  • As at 22 Nov 17, the forward P/E of FSTTC index is trading close to -0.7SD below its 5- year mean, reflecting the ongoing challenges in the industry.

2) Mobile Segment ARPU likely to remain weak 

  • For 9MCY17, the three telcos cumulatively added 73k in net new postpaid subscribers, and the proportion of 4G users has risen to around 86% of the total 3G and 4G subscriber base of the three telcos as at 30 Sep 17. Average revenue per user (ARPU) remains under pressure with the three telcos citing lower voice, IDD and roaming usage (both inbound and outbound) as the key reasons. 
  • Looking ahead, coupled with heightened competition, we expect ARPU to remain weak given the increasing adoption of over-the-top services (OTT), as subscribers switch to using data for calls instead of using the traditional call services. In our view, the trend of increasing data usage will persist, as the telcos continue to offer higher and even unlimited data plans to entice consumers to switch to them, though these plans may not be the best way to monetize data usage for now.

MyRepublic yet to launch mobile services as MVNO 

  • Recall that back in Jul 17, local fibre broadband operator MyRepublic (MR) announced its plan to launch mobile services in Singapore as the second MVNO as early as Oct 17. With the month passed, MR has neither launched its mobile services, nor announced any concrete agreement with respect to buying mobile bandwidth wholesale from one of the existing telcos.
  • That said, we note that the Oct 17 timeline was not a commitment but rather a plausible timeline for MR to work on. Hence, we expect the potential entry by MR as the second MVNO will add pressure on the already competitive landscape within the telecom sector. MR has stated that their strategy will be to offer generous mobile data, and leverage on its existing fibre broadband customer base to secure new mobile customers, and looking at no more than 5-6% market share.
  • In Singapore’s saturated market, as the space gets more crowded with more mobile service providers offering similar services, pricing power will fall amid limited growth in subscribers. Hence, we expect ARPU to continue its decline with the entry of TPG and potentially MR.

Aggressive plans to protect market share 

  • Following the launch of unlimited data plans by Starhub and M1 in Aug 17, Singtel also did the same in Oct 17.
  • While the unlimited data plans across the three telcos have different structures, the underlying objective is the same, in our view – to protect or even gain market share by targeting data-hungry customers. As highlighted above, while these unlimited data plans may not be the best way to monetize data usage, it is necessary to protect market share and retain customers amid the increasingly competitive landscape in Singapore’s telecom sector.

Data monetization key for long-term growth 

  • Average monthly smartphone post-paid data usage has been increasing across all three telcos: 
    • M1 saw an increase from 3.6GB in 4Q16 to 4.2GB in 3Q17, 
    • Starhub recorded an increase from 3.7GB in 4Q16 to 4.5GB in 3Q17, and lastly, 
    • Singtel posted an increase from 3.2GB in 4Q16 (or 3QFY17) to 3.6GB in 3Q17 (or 2QFY18).
  • Clearly, data usage by consumers has been on an upward trend, and we expect this trend to continue ahead. Without a doubt, it remains unclear at this point in time on how best to monetize data usage given the impending entry of TPG as well as the announced intention of MR to launch mobile services as well. Hence, over the longer-term, we believe the ability to monetize data usage will be a key focus for all the players in the industry.
  • Hence, on the back of persistent competition, we are keeping our ARPU forecasts unchanged as we do not see any catalysts in the near-term for any rebound in ARPU. For the period CY16 to CY21, we forecast for postpaid mobile ARPUs of Singtel, Starhub and M1 to register CAGR of -2.4%, -3.4% and -4.3%, respectively.
  • As highlighted previously, with Singapore’s mobile penetration rate already at ~149%, growth in number of subscribers going forward will be limited and slow, if any. Coupled with the forecasted decline in ARPU, we expect total mobile revenue to fall ~13.6% between CY16 and CY21 (FY22 for Singtel). We continue to estimate TPG to achieve ~6% mobile revenue share by CY21.

3) Broadband Segment High penetration makes competition tougher 

  • Singapore’s residential broadband market remained stable with insignificant YTD growth in number of subscriptions. Singtel and M1 added a total of 10k in new customers between 2QCY17 and 3QCY17 but Starhub’s broadband subscriber base fell by 1k during the same period. 
  • As at end-3QCY17, total broadband subscriber base of the three telcos was 1.27m subscribers, which represents ~94.1% (end- 4QCY16: 92.7%) of the overall Singapore broadband market. ARPU across all three telcos has been stable for the 9MCY17 period.
  • All said, the stability in ARPU may not be here to stay with the impending entry of TPG. With the ability to leverage on Singapore’s Next Generation Nationwide Broadband Network (NGNBN), it makes sense for TPG to launch fibre broadband services, so as to complement its mobile services when launched, in order to compete more effectively by offering bundled plans. 
  • TPG is already an established fixed service provider and no-frills MVNO in Australia, and we expect its experience will help keep its cost structure lean to compete effectively across both markets.
  • Separately, MR may potentially be the one to inject competition into the broadband scene with its intention to launch mobile services as MVNO. If it does so, we see scope for MR to offer even more attractive price plans to consumers who sign up for both broadband and mobile services with them. 
  • Note that MR is already an existing broadband provider in Singapore, which makes them one step ahead of TPG.

4) Pay TV Segment ARPU holding up despite falling subscriber base 

  • Coupled with problems of content piracy, the increasing adoption by consumers in using OTT content service providers (e.g. Netflix, VIU etc.), continued to plague the Pay TV market. 
  • YTD, the total number of Pay TV subscribers as at end-3QCY17 fell 4.0% to 871k. For 3QCY17, Starhub’s Pay TV subscriber base fell 2.1% QoQ to 467k subscribers while Singtel’s subscriber base remained flat at 404k. Pay TV ARPU for both Starhub and Singtel stayed stable QoQ with no change at S$51 and S$41, respectively. We believe the stability of the two telcos’ ARPU is supported by their strategy to focus on retaining higher-value customers.
  • While both Singtel and Starhub continue to make efforts to manage the contents offered on their Pay TV platforms, we are expecting the downward trend to persist with more subscribers switching to OTT service providers. Even if the two telcos manage to keep ARPU stable, revenue will likely be on a downward trend as the subscriber base shrinks over time.

5) Recommendations 

Starhub and M1 – significant exposure to local mobile segment 

  • Based on 9M17 results, ~55% of Starhub’s service revenue and ~85% of M1’s revenue is derived from Singapore’s mobile (excluding handset sales) segment. If we include handset sales, ~51% of Starhub total revenue and ~88% of M1 total revenue is derived from Singapore’s mobile segment. This clearly shows that both telcos still have significant exposure to the under-pressure Singapore mobile market.

Singtel the only one with diversified revenue base 

  • For Singtel, based on 1HFY18 (i.e. 2QCY17 – 3QCY17) results, we estimate its effective exposure to Singapore’s mobile segment to be only ~4% of its 1HFY18 total group revenue. Assuming that Singtel’s 1HFY18 Singapore consumer EBITDA breakdown is similar to its Singapore revenue breakdown, we estimate that its effective exposure to Singapore’s mobile segment in terms of EBITDA is also only ~4% of its 1HFY18 total EBITDA. This clearly shows that Singtel’s business composition differs vastly from the other two telcos given its broad revenue base, supported by a diversified portfolio of businesses.
  • Apart from the Singapore mobile market, Singtel is also facing increasing pressure in Australia as TPG also won the bid to become Australia’s 4th telco, similar to the situation in Singapore. Based on 1HFY18 results, we estimate Singtel’s effective exposure to Australia’s mobile segment to be at a higher ~16% and 15% of its 1HFY18 total revenue and EBITDA, respectively. Clearly, Australia’s mobile business poses a greater potential impact than Singapore’s mobile business but in our view, not a significant concern for Singtel as a group.

Dividend yield support remains important 

  • In our view, given Starhub’s and M1’s significant exposures to the Singapore mobile market, we expect their earnings to continue to be under pressure, which may translate to lower dividends beyond FY17.
  • Recall Starhub has already cut its dividend from S$0.05/quarter in past years to S$0.04/quarter in FY17, while M1 continues to maintain its guidance of 80% payout ratio.
  • Given declining earnings outlook, we expect M1’s dividend yields to fall over the next few years as earnings decline, assuming payout ratio is being maintained at 80%. That said, we believe this has been largely priced-in for M1. However, while we are negative on Starhub at the moment based on current share price, we would look to review our assumptions again once we see more consistent growth and contributions from its enterprise segment. 
  • Recall that 3Q17 results already gave some indications that its enterprise segment, which Starhub had invested heavily into over the past few years, is starting to gain traction. This means with heavy capital expenditure at its tail-end, free cash flow may not decline even as earnings fall. This allows Starhub to possibly maintain its dividend of S$0.04/quarter, even beyond FY17. That said, for now, we prefer to wait for clarity as its mobile business remains under pressure.
  • For Singtel, with the S$2.3b cash received from the IPO of NLT, we expect near-term dividends to remain stable on the back of resilient earnings. Over the medium to longer-term, we are positive on the potential high growth coming from Singtel’s enterprise and digital life segment on the back of increasing demand for cyber security, data analytics and digital marketing services. With much of the NLT IPO proceeds kept internally, we expect more M&A acquisitions going forward to further grow the capabilities of its enterprise business.

Maintain NEUTRAL on Singapore Telecom Sector 

  • We are maintaining our NEUTRAL rating on the sector, having seen quite steep price corrections over at least the past year. 
  • We believe M1 is fairly priced while we see upside potential for Singtel as we believe its share price correction being overdone. For Starhub, we see scope for further downside for now.

Reiterate BUY on Singtel 

  • Within the sector, we reiterate Singtel [BUY; FV: S$4.19] as our top pick, supported by a forward dividend yield of 5.5%. We are positive on Singtel’s longer-term outlook given its growing presence in the digital space – cyber security, data analytics and digital marketing, all of which we believe are industries with high growth potential as Singapore transforms towards a digital economy.

Maintain SELL on Starhub 

  • For Starhub, we expect earnings ahead to be dragged by weak mobile and Pay TV segments, and also prefer to wait for clearer indications of its enterprise business gaining consistent and stronger traction. Hence, at the current price, maintain SELL on Starhub with an unchanged FV of S$2.30. In the near-term, we believe its share price will be supported by its forward dividend yield 5.6%.

Maintain HOLD on M1 

  • While M1 has the most exposure to the Singapore mobile market, we believe it is currently trading near its fair value. Hence, we are maintaining our HOLD rating on M1 with a 12-month fair value estimate of S$1.65. We believe its share price in the near term will be supported by its forward dividend yield of 6.9%. That said, with declining earnings outlook, we expect dividends (assuming 80% payout) to fall over the next few years.

Eugene Chua OCBC Investment | http://www.ocbcresearch.com/ 2017-11-23
OCBC Investment SGX Stock Analyst Report BUY Maintain BUY 4.190 Same 4.190
SELL Maintain SELL 2.300 Same 2.300
HOLD Maintain HOLD 1.650 Same 1.650