NetLink NBN Trust - DBS Research 2018-07-02: Addressing Recent Share Price Correction

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NETLINK NBN TRUST SGX: CJLU

NetLink NBN Trust - Addressing Recent Share Price Correction

• NetLink NBN Trust's share price has corrected c.7% (ex-div) amid increase in 10-year Singapore bond yield and broader market weakness.
• NetLink NBN Trust should trade at a tighter yield spread.
• Stock offers attractive dividend yield of c.6.4% for FY19F.
• Maintain BUY, Target Price revised to S$0.87.

NetLink Trust NLT should trade at tighter yield spreads than industrial S-REITS.

• Amid an increase in the 10-year Singapore bond yield and broader market weakness, NetLink NBN Trust (NLT)’s share price has corrected c.7% (ex-div) YTD. NetLink Trust is trading at c.6.4% FY19F yield, similar to large-cap industrial S-REIT’s average yield. 
• We argue that NetLink Trust should trade at a tighter spread than S-REITs as
  1. NetLink Trust’s distributions, due to the regulated nature of its business, are largely independent of the economic cycle
  2. NetLink Trust’s gearing is less than half of S-REITs’ with an ample debt-headroom to fund future growth.
• We believe that the current FY19F dividend yield of c.6.4% is attractive versus our target yield of 5.5%.

Where we differ:

• Market may be overly concerned that rising interest rates may lead to a search for higher yields. NetLink Trust has hedged its interest rates till March 2021 and growth in distributions should translate into higher yields.
• NetLink Trust's one unique advantage over REITs and Business Trusts is that potential rise in the cost of capital might lead to higher regulated returns from 2022 onwards, translating into higher distributions.

Potential catalysts:

1. Wider scope of Smart Nation initiatives - NetLink Trust could use its debt headroom to invest in those initiatives, leading to a healthy growth in distributions in the long term, which we have not priced into our target price and
2. More clarity on 5G rollout and NetLink Trust’s potential participation if any.

Valuation:

• Maintain BUY, Target Price revised to S$0.87. 
• Our DCF valuation is based on a revised WACC of 6% (5.6% previously) on higher cost of debt and volatility assumptions, and terminal growth of 1.2% (long-term household formation rate).

Key Risks to Our View:

• Bear case valuation of S$0.68 on sharper than expected rate hike on current yield spread. Bear case scenario could see NetLink Trust could trade at S$0.68 towards 7% yield on higher than expected 10-year bond yields.
• Other key risks will be regulatory risks as any reduction in regulatory returns from 2022 onwards may lead to lower Interconnection Offer (ICO) pricing.

WHAT’S NEW - Currently trading at similar yield to average S-REITs yield.

• Amid an increase in the 10-year Singapore bond yield and broader market weakness, NetLink Trust’s share price has corrected c.7% and the stock is now trading at c.6.2% FY19F (FYE Mar) yield, similar to current S-REITs sector average yield for 2018. 
• While we note that S-REITs have different underlying assets compared to NetLink Trust’s regulated assets with varying asset useful life/lease, as well as growth prospects, S-REITs are a good benchmark in evaluating the yield spreads that the market is looking at.

NLT should trade at tighter yield spread.

• Assuming a 10-year Singapore bond yield of 2.7% by end of 2018, NetLink Trust is currently trading at c.3.7% yield spread. This is similar to large-cap industrial REITs which we believe have similar asset lives as NetLink Trust’s core ducts and manholes of c.40 years. 
• We believe NetLink Trust should trade at tighter yield spreads at c. 2.8% compared to the large-cap industrial REITs current yield spread of c.3.6% for the following reasons:
  1. Lower earnings volatility: NetLink Trust’s business environment is less volatile as 92% of its businesses are regulated with the remaining businesses on contractual terms. Broadband connections are essentially considered as “staples” in most households and corporates and hence demand for broadband connections are not volatile. NetLink Trust’s earnings are not subjected to economic cycles, unlike that of REITs.
  2. Ample debt-headroom for future growth: Projected FY19F total debt-to-EBITDA ratio of 2.7x is much lower than the 5.3x average for Business Trusts in Singapore/Hong Kong, implying room for higher growth through optimising its capital structure. Compared to S-REITs, NetLink Trust is also less leveraged in general, with total debt/equity ratio at 22%, compared to S-REITs sector average of c. 50-60%.
  3. Unique position as sole nationwide provider of critical infrastructure for residential broadband: NetLink Trust is in a unique position as the sole nationwide provider of critical infrastructure for Singapore’s residential broadband, which supports its residential broadband earnings.

Currently trading at attractive FY19F dividend yield of c.6.4%.

• During the recent results briefing, NetLink Trust reiterated that FY19’s distribution will be as per forecast in the IPO prospectus (4.64 Singapore cents), representing 6.2% dividend yield at current prices. Based on our estimates, NetLink Trust should be able to deliver a slightly higher FY19 distribution on lower cost assumptions.
• The current dividend yield of c.6.4% is attractive based on our higher distribution estimate on lower costs assumptions.

Other concerns.

• We understand that the market may be concerned about future changes in Interconnection Offer (ICO) pricing.
• On ICO pricing, the current pre-tax WACC of 7% has been set for the period Jan 2018 to Dec 2022 and any adjustment to the pre-tax WACC will impact regulatory pricing. However, we believe that the regulator would continue to allow NetLink Trust to generate additional returns from incremental capex and hence ICO price risk is not a main concern at the moment.

Maintain BUY with revised Target Price of S$0.87.

• Our DCF valuation is based on a revised WACC of 6% on higher cost of debt assumptions (previous WACC 5.6%), and terminal growth of 1.2% (long-term household formation rate).
• At S$0.87, NetLink Trust is trading at a yield of c.5.5%.

Sachin MITTAL DBS Vickers | Rui Wen LIM DBS Vickers | https://www.dbsvickers.com/ 2018-07-02

SGX Stock Analyst Report BUY Maintain BUY 0.87 Down 0.970