NetLink NBN Trust - DBS Research 2018-02-06: Earnings Surprise From Cost Savings

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NETLINK NBN TRUST CJLU.SI

NetLink NBN Trust - Earnings Surprise From Cost Savings

• 3Q18 earnings beat NetLink NBN Trust’s forecast by 32% due to lower costs; FY18F/19F earnings raised 11%/9%.
• Higher earnings should not be a regulatory concern as there should be incentive for efficiency in our view.
• BUY with revised Target Price of S$0.97.

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 5.7% now) reflecting lower earnings volatility and ample debt-headroom for future growth.
• NetLink NBN Trust’s business environment is less volatile as 92% of the business is regulated. 
• Projected FY19F total debt-to-EBITDA ratio of 3.2x is much lower than the 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 yield. NetLink NBN Trust 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 might lead to higher regulated returns from 2022 onwards, translating into higher distributions.

Potential catalysts:

1. Newsflow on TPG Telecom’s backhaul rollout leveraging on NetLink NBN Trust’s infrastructure in early 2018,
2. Widened scope of Smart Nation initiatives as NetLink NBN Trust could use its debt headroom to invest in those initiatives, leading to a healthy growth in distributions in the long term, and
3. More clarity on 5G rollout and if NetLink NBN Trust could be involved in the 5G rollout.

Valuation

• Maintain BUY with a revised Target Price of S$0.97 as we raise our FY18F/19F earnings by 11%/9% on account of cost savings.
• Our DCF valuation is based on WACC of 5.7% and terminal growth of 1.2% (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 - Big surprise on earnings 

3Q18 earnings beat NLT’s forecast by 32% due to lower operating and staff costs. 

• 3Q18 revenue at S$83.4m was 0.6% higher than NetLink NBN Trust (NLT)’s forecast, mainly due to higher monthly recurring Residential and Non-Residential connection revenue than forecast. 
• 3Q18’s EBITDA and net profit were higher than forecast by 11% and 32% respectively.

Total expenses for 3Q18 of S$63.8m was S$5.3m lower than forecast.

• Operation and maintenance (O&M) cost was S$1.4m less than forecast, mainly due to lower operating needs and deferments on timing reasons but will be incurred in future periods. Other operating expenses was S$1.8m below forecast, due to lower IT maintenance and professional costs. 
• Staff costs was S$1.5m lower as the actual average headcount was below the forecast number, and higher capitalisation of labour costs as more projects were completed as compared to forecast.

Good traction in growing end-user connections: 

• As of 31 December 2017, NLT had 1.17m (30 September 2017: 1.14m) residential connections, on track to achieve its full-year target. 
• Non-residential connections gained good growth traction and stood at 43,228 for the quarter (30 September 2017: 42,028), exceeding its full-year target of 42,800 connections. 
• NLT continues to support requesting licensees (e.g. Starhub) to acquire new corporate and NBAP customers.

FY18F/19F earnings revised by 11%/9%. 

• We expect operating cost to bump up as Q3 also benefitted from deferments due to the timing reasons. In addition, we expect staff costs to rise in FY19F before dropping in FY20F as NLT is likely to hire more people to complete its major billing project in FY19F.

Higher-than-expected profit should not be regulatory concern. 

• NLT operates on the basis of fixed returns on forecast capex over the next five years. Theoretically, higher-than-expected returns may trigger a mid-term review after three years by the regulator but we think it is unlikely as there should be incentive for NLT to be more efficient, in our view.
• Also there is a possibility that NLT could expend more capex than the forecast capex eligible for regulatory return depending upon the demand, justifying higher-than-forecast earnings.

Sachin MITTAL DBS Vickers | Singapore Research DBS Vickers | http://www.dbsvickers.com/ 2018-02-06

DBS Vickers SGX Stock Analyst Report BUY Maintain BUY 0.97 Up 0.950