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Morningstar | Competition Ramping Up in Singapore and SingTel’s Associates; FVE Reduced to SGD 2.75

We reduce our fair value estimate for Singapore Telecommunications to SGD 2.75 per share from SGD 2.85 per share following the release of weaker-than-expected first-quarter results from the Singapore domestic business and share price falls from the Associates. Fourth-quarter group revenue was flat with EBITDA down by 9.6% and underlying net profit down 22%. The strong SGD reduced revenue, EBITDA, and underlying net profit by 4 percentage points each. A reasonable performance in Australia with Optus revenue up 5.5% and EBITDA down 0.4% was offset by weakness in Singapore with EBITDA declining by 10% on the back of 5% mobile services revenue decline and contributions from Associates that were down 50% due declines across most of its Associate portfolio. We retain our narrow moat rating for the company.

Our fair value estimate implies a price/earnings ratio for SingTel of 13.6 times, which is slightly ahead of its average over the past 10 years. On our valuation, the associate businesses are worth slightly more than SingTel’s consolidated Singapore and Australian businesses. The stock remains a dividend play, with the company previously indicating that “barring unforeseen circumstances” it expects to maintain its SGD 0.175 ordinary dividend in each of the next two years and thereafter reverting to a payout ratio of between 60% to 75%. This dividend level puts the stock on a dividend yield of 5.6%, but with the current declining earnings, TPG entering the mobile market in Singapore and potentially lumpy 5G mobile capital expenditures at some stage over the next 3-4 years, dividends in fiscal 2021 and beyond are less certain. Our base case has dividends falling to SGD 0.15 per year from fiscal 2021 to 2023.

Optus, the Australian business, reported revenue up 5.5% for the second quarter and EBITDA down 0.4% in Australian dollar terms, with flat mobile services revenue. Competition in the Australian mobile market seems to have stepped up this year with all operators, including incumbent Telstra, offering reasonably priced unlimited data plans. However, the outlook for this business has improved with TPG shelving its plans to build its own mobile network and announcing at the end of August 2018 plans to merge with Vodafone Australia. Prior to this we were expecting TPG to cause disruption in the market as it tried to fill its network with traffic and customers. Mobile contributes around 60% of Optus’ revenue, and we estimate around 80% of the profits. Optus’ performance in the mobile market improved in the first half of calendar 2018 with Optus service revenue declining by 1.4% and EBITDA declining by 3% compared with the industry service revenue declining by 1.6% and EBITDA declining by 7% on our estimates, so it was doing relatively well in an ordinary looking market. For Optus we forecast broadly flat EBITDA over the five-year forecast period.

The Singapore domestic business also continues to struggle with revenue increasing by 2.3% while EBITDA declined by 10%. There are a number of issues driving the margin reduction, including reduced high margin mobile revenue, which was down 5.2%, and managed services revenue, which was down 3.7%. Growth is coming from its lower margin business solutions (10%) and equipment sales (38%). We note that the shift in accounting standards to IFRS 15 means that in periods of high handset sales, services revenue will be negatively impacted and more revenue and profit is recorded in handset sales. This was one explanation given for the poor mobile services revenue growth in a quarter where customer growth was quite strong. With TPG confirmed to launch a mobile network in Singapore in 2018 without the geographical coverage limitations likely evident in Australia, competition is likely to get even tougher going forward. The decline in managed services revenue was due to a particularly strong quarter a year ago, the Singapore Government putting certain projects on hold for six weeks this quarter, and the general lumpiness of this business. Management remains confident of the outlook for this business. For SingTel’s domestic operations we forecast around 1% per year EBITDA over the next five years driven by these newer digital and cyber security businesses offsetting declines from mobile and some of the legacy voice services.

Digital Life, SingTel’s collection of Internet businesses, reported its first EBITDA breakeven quarter in the fourth quarter last year but fell back to and EBITDA loss of SGD 23 million in the first quarter and this grew to a SGD 34 million loss in the second quarter. Amobee saw revenue increase 9% but moved back to an EBITDA loss of SGD 10 million this quarter after generating positive SGD 31 million EBITDA for the full year last year. Management admitted that a structural shift was occurring where customers were shifting from media to programmatic purchase of advertising that negatively impacted the result. It claimed that Amobee was well position in this space but gave little details. Digital Life is small in relation to the core telecom businesses and we have little visibility. The division is attempting to use Internet technologies and leverage the Group’s broad subscriber base reach and huge customer information database to add value to small acquired companies in the space. It is focused in three areas; digital marketing, mobile video, and data analytics. Without detailed information on each of the businesses, proper analysis is difficult for external investors and analysts, and we suspect that investors will continue to discount these investments until they show profitability or at least a clear path to profitability.

Post-tax contribution from associates was down 22% with only Globe in the Philippines and Airtel’s operations in Africa providing positive momentum. Bharti’s contribution from India and South Asia remained in losses in the face of Reliance Jio’s onslaught, while contribution from the largest Associate by profit contribution, Telkomsel in Indonesia, was down by 23%. SingTel earned SGD 1,648 million in dividends from associates in fiscal 2018, which was largely flat year on year. Given the associate earnings decline this financial year, the company is forecasting the receipt of dividends to fall to around SGD 1.4 billion in fiscal 2019.