StarHub - DBS Research 2018-02-19: Cost Escalations A Bane

StarHub - DBS Vickers 2018-02-19: Cost Escalations A Bane STARHUB LTD CC3.SI

StarHub - Cost Escalations A Bane

  • Excluding one-offs, StarHub's net profit for 4Q17 was below expectations.
  • Acquisition-led growth in the enterprise segment helped offset losses in mobile and Pay TV.
  • The counter is expensive despite a decent dividend yield.
  • Maintain FULLY VALUED with an unchanged Target Price of S$2.20.

What’s New 

Enterprise segment was the sole bright light. 

  • 4Q17 service revenues of S$571.7m (+0.8% y-o-y, +4.8% q-o-q) was in line with expectations. 
  • Revenues from the enterprise segment grew 20.9% y-o-y, largely supported by the acquisition of Accel Systems, offsetting losses in mobile and Pay TV. Mobile service revenues for the quarter declined 3.5% y-o-y with the higher take-up of SIM-Only plans and continuing decline in legacy usage. Pay TV revenues declined 7.4% y-o-y amid the continued loss of Pay TV subscribers.

Earnings excluding one-offs were below expectations. 

  • 4Q17 earnings of S$14.3m (-74% y-o-y, -81% q-o-q) were weighed down by higher cost of sales and one-off staffrelated and operating lease expenses. Excluding one-offs, earnings were estimated to be ~S$37m which was still below our expectations. 
  • Earnings were dragged down by higher handset subsidies which grew ~8% y-o-y during the quarter with M1 stirring up competition for premium subscribers in the marketplace. Rising cost of services (+23% y-o-y, +24% q-o-q) driven by higher managed services and fibre broadband costs owing to the migration of cable customers to the fibre network also weighed on earnings.
  • Lower traffic expenses which declined ~35% partially offset the higher expenses.

Market seems to be overly optimistic about StarHub’s enterprise business. 

  • We estimate that the market is currently valuing StarHub on the assumption of ~20% growth in the enterprise business over FY18-21 vs our base-case projections of high single-digit growth. 
  • We remain skeptical of StarHub expanding its enterprise business in the double digits as
    1. market leader Singtel has only recorded 5-6% growth in its enterprise business historically,
    2. voice business presently accounts for ~10% of StarHub’s enterprise revenues, and decline in this segment is accelerating,
    3. increasing competition from M1 and the entry of specialised solution providers in the enterprise space. 
    These factors could impede StarHub’s efforts to expand its enterprise business.
  • Furthermore, we believe that growth in StarHub’s enterprise business primarily stems from its ICT portfolio, a segment that inherently fetches lower margins than traditional enterprise services. Hence, despite the robust growth in enterprise revenues, EBITDA margins in the enterprise segment are likely to edge lower with increasing contribution from ICT services. This could result in StarHub’s earnings growth falling short of market expectations.

StarHub’s hubbing strategy under pressure. 

  • StarHub’s go-to-market strategy of bundling mobile, broadband and Pay TV services is under pressure from the proliferation of over-the-top (OTT) TV services. 
  • Nearly 24,000 customers with subscriptions to three or more services have downgraded since 1Q16, representing ~7% of subscriptions with three or more services. The majority of these customers are moving away from Pay TV to cheaper alternatives such as Netflix, despite losing the discount available on bundled services in the process. 
  • We believe downgrades of hubbing subscriptions would accelerate amid the increasing appeal of OTT TV services among high-end Pay TV customers and rising pressure on the broadband segment from M1 and MyRepublic. As this is a critical success factor for StarHub, there could be near-term impact on the company's share price as the structural decline is unlikely to reverse.

The counter is expensive despite a decent dividend yield. 

  • On valuation, StarHub is expensive at a forward PE of 21x (versus sector average of 15x) and 10.2x EV/EBITDA (versus sector average of 8.5x) as investors tend to value the company in terms of dividend yield. 
  • While StarHub maintained an annual DPS of 16 Scts in 2017 (5.6% yield), its annual DPS could be cut to 14 Scts in FY19F to stay below 2.0x net debt-to-EBITDA.

Maintain FULLY VALUED with an unchanged Target Price of S$2.20.

  • We arrive at a DCF-based Target Price of S$2.20 with a 6.0% WACC and 0% terminal growth. At current prices, the counter is overvalued by ~15%.

Sachin MITTAL DBS Vickers | http://www.dbsvickers.com/ 2018-02-19
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