Singtel - DBS Research 2018-11-02: How Will Singtel Look In 5 Years’ Time

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SINGTEL (SGX:Z74)

Singtel - How Will Singtel Look In 5 Years’ Time

• Expect 2Q19F underlying earnings to rebound 11% q-o-q to S$811m, confirming 1Q19 as the bottom.
• Growth businesses to comprise 70% of revenue in 5years versus 43% now; EBITDA growth in core marketsto accelerate to 5-6% in FY21F versus flat EBITDA now.
• Reiterate BUY with Target Price of S$3.64.

2Q19F results to confirm 1Q19 was the bottom.

• Singtel is likely to meet 2Q19F consensus projections with underlying earnings of S$811m (+11% q-o-q, -13% y-o-y) when it reports its results on Nov 7, confirming 1Q19 earnings as the bottom.
• Associates’ profit contribution has been a critical factor for Singtel’s share price historically and a rebound in associate contributions could prompt the market to re-rate the counter.
• Singtel is attractive, trading at 12-month forward PE of 16x, -1SD of its historical average of 17x, and offers a 6% EPS CAGR over FY19F-21F and 5.5% yield based on DPS of 17.5Scts.

Where we differ

• Street is ignoring the shift in EBITDA growth potential in core markets from the transformation. We project growth businesses to comprise ~70% of revenue in 5 years versus 43% last year, and only 17% in FY13.
• A larger base of growth businesses should accelerate revenue growth to 7-8% in FY21F versus 2-3% now, leading to ~5-6% growth in EBITDA versus flattish EBITDA in the core markets currently.

Potential Catalysts:

• Sequential rise in Singtel’s earnings in 2Q19F led by Telkomsel’s recovery, 6.8 Scts DPS to be paid in December, Singtel raising its stakes in regional associates.

Valuation:

• BUY with an unchanged Target Price of S$3.64.
• We maintain our sum-of-the-parts (SOTP) valuation at S$3.64 and reiterate our BUY call on the back of a rebound in associate contributions, attractive valuations, and ~5.5% dividend yield.

Key Risks to Our View:

• Bear case valuation of S$2.70 suggests -9% risk. This assumes
  1. 20% drop in the valuation of Singapore and Australia business due to EBITDA decline vs. stable EBITDA,
  2. 20% drop in valuations of Bharti and Telkomsel, and 10% drop in market cap of other associates;
  3. 15% holding company discount vs. 5% base case.

WHAT’S NEW - 2Q19F results preview

Associate earnings to rebound in 2Q19F.

• Stronger than expected recovery of Telkomsel to support rebound in associate contributions. Singtel’s biggest associate, Telkomsel, reported 3QFY18 earnings of Rp 6.6trn (+24% q-o-q, -16% y-o-y) - ahead of our estimates.
• Telkomsel’s cellular revenues expanded 10.1% q-o-q (~-2.3% y-o-y), supported by an 8% q-o-q improvement in data yields, driving up data revenues by 18% q-o-q (+20% y-o-y). Telkomsel achieved ~4- 11% improvement in data yields through a series of quota curtailments and pricing revisions in June, in a bid to lift the very depressed industry yields. Factoring in the depreciation of the Indonesian Rupiah vs. the Singapore Dollar, we expect Singtel to record ~S$217m (-21% y-o-y,+21% q-o-q) post-tax earnings contribution from Telkomsel.
• We believe SingTel would record 7-8% growth in contributions from Telkomsel in FY19F supported by benign competitive conditions in Java, which contributes ~40% of Telkomsel’s top line.

AIS and Globe to further support recovery.

• We expect contributions from AIS and Globe to expand 2%/4% q-o-q (+16%/19% y-o-y) supported by benign competition in Thailand and growing data and corporate revenues in the Philippines respectively.
• AIS’ topline should be supported by subscriber additions from DTAC, fixed broadband revenue growth due to the low base in FY17, and the consolidation of the CS Loxinfo business. Lower marketing and SG&A should partially offset the impact of higher cost of services and depreciation owing to 4G expansion, driving up core earnings to Bt8.2bn (+10.8% y-o-y, +4.1% q-o-q).
• Globe should also benefit from growing mobile data revenues (~38% of service revenues) and improving uptake in the home broadband and corporate data (including managed services) segments.

Marginal post-tax contribution from Bharti supported by deferred tax gains.

• Bharti Airtel’s 2Q19 EBITDA was ~5%, below consensus’ estimate of INR 63.4bn (-21% y-o-y, -7.2% q-o-q) due to weak mobile revenue in India and a sharp rise in Network operating expenses.
• Mobile service revenues from India dipped 2.3% q-o-q (vs. +0.8% q-o-q growth in 1Q19) as Airtel lost ~6.6m subscribers, most likely due to the impact of the Jio Phone Monsoon Hungama scheme, where customers can exchange their old phones for a new JioPhone for free (a refundable security deposit of Rs 501 is still applicable). Network operating expenses (~40% of opex) also expanded 10.6% q-o-q as Vodafone-Idea exited some of the towers occupied by Airtel, driving down EBITDA margins by 300bps on a q-o-q basis, to 31.1%. Despite heavy losses in India and South Asia, Airtel recorded a net profit of INR 1.2bn (-65% y-o-y, +22% q-o-q) due to exceptional gains (net of tax) of INR 10.4bn, largely arising from a one-off deferred tax gain of INR 26.3bn.
• As Singtel accounts for exceptional items as part of the post-tax associate income, contribution from Airtel is likely to be marginally positive in 2Q19F as per our estimates (despite a pre-tax loss of ~S$140m), subject to potential contributions from Bharti Telecom, the holding company of Bharti Airtel.

Longer term outlook -

Growth businesses may comprise ~70% of the total business in 5-years versus 43% last year.

• Revenue growth is likely to accelerate from FY21F onwards due to the mix. Growth business is comprised of mobile internet, digital advertising and over-the-top (OTT) video, cyber-security and the provisioning of IT corporate solutions. Growth business made up ~42% of the total revenue in FY18.
• We expect contribution from the growth businesses to overtake legacy business in FY20F and comprise ~70% of the topline in 5 years. We assume growth businesses to record a CAGR of 15% over FY17-23F (vs. 19% CAGR over FY13-18) while legacy services to decline at an average annual rate of ~8% as seen over FY13-18.
• Overall, we think that revenue growth could jump from 3-4% to 7-8% from FY21F onwards with growth businesses comprising 55-60% of total revenue.

With higher revenue growth, EBITDA could start to grow by 5- 6% from FY21F onwards versus flat EBITDA now.

• Firstly, sub-scale businesses like Digital advertising and Cyber-Security are likely to report better EBITDA.
• Secondly, with operating expenses ~S$12.7bn in FY18, we can expect Singtel to increase its productivity by ~4-5% each year or achieve about S$500m in cost savings annually with increasing automation.

HOOQ likely to reach EBITDA breakeven on revenue of US$100m.

• HOOQ, the regional OTT video service of Singtel, is presently investing heavily to ramp up scale and acquire content to lure subscribers to the platform, which has resulted in heavy EBITDA losses from the service. The management expects HOOQ to reach EBITDA breakeven with revenues of ~US$100m (vs. ~FY18 revenues of US$17m from the Digital life segment).
• While HOOQ could take a few more years to reach breakeven EBITDA, we expect to see narrowing losses from the service as the management intends to shift bulk of the content spend towards localised, Asian content, which is significantly cheaper than Hollywood content. This should support lower losses in EBITDA from Digital life excluding Amobee in our view.

Cyber-security business should turn EBITDA positive with scale.

• Cyber-security remains a low-margin business as acquiring and training cyber-security talent and managing Security Operations Centres (Singtel has 10 Security operation centers) remains cost intensive. The business also requires continuous investments in Research, thus pushing down margins even further. Hence, acquiring scale remains pivotally important to reach positive EBITDA in cyber-security businesses in our view.
• We take cues from Secureworks, a Managed Security Service Provider based in the US. Secureworks recorded its first adjusted EBITDA in 2Q18 (July 2018), on quarterly revenue of ~S$175m (US$ 128m), highest revenue recorded by the company after its listing in April 2016.
• Singtel’s cybersecurity business remains smaller in size to its peer but with cybersecurity revenues expanding in low teens, Singtel should be able to secure sufficient scale required to bring in positive EBITDA from the cyber-security operations over the next 2 years in our view.

Sachin MITTAL DBS Group Research | https://www.dbsvickers.com/ 2018-11-02

SGX Stock Analyst Report BUY MAINTAIN BUY 3.640 SAME 3.640