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Morningstar | StarHub is Looking to Stabilize Profits over the Year; We Retain FVE at SGD 1.75

StarHub’s first-quarter 2019 was in line with our expectations and there was no change to guidance. First-quarter services revenue decreased by 1% with operating profit and net profit down 14%. Cyber security revenue grew by 41% due mainly to acquisitions but operating profit from this activity fell by SGD 16.5 million to an SGD 11.4 million loss. Without the extra cybersecurity activity, operating profit would have been broadly flat. The company continues to guide to service revenue to decline by 2% in 2019 with EBITDA margin of 30%-32%. Capital expenditures, excluding the spectrum payment of SGD 282 million, will be around 11%-12% of total revenue. Dividend payout will be 80% and will be SGD 2.25 cents per quarter for the first three quarters with any payment of above 9 cents to be made in the fourth quarter. Recall that various one-time provisions were raised in the fourth quarter 2018 which should help the company to achieve this guidance. We retain our thesis that the company’s profits will remain under pressure for at least the next two years due to increased mobile competition and the secular decline of pay TV negatively impacting on StarHub’s traditional bundling strategy.

We retain our forecasts and fair value estimate of SGD 1.75 per share and would advise investors to wait for a better entry opportunity. We make no change to our narrow moat rating on StarHub based on cost advantage and efficient scale, with the company continuing to earn returns marginally above its cost of capital despite expectations for ROIC to fall from 21% in 2015 to 8.9% in 2019 before recovering to 10.6% in 2023 compared with a 7.9% WACC. The fall in forecast returns, due primarily to the introduction of a new entrant into the mobile market this year and the secular decline of the company’s pay TV service due to over-the-top video services such as Netflix and pirated video content, drive our negative moat trend rating.

Mobile is still the biggest revenue stream accounting for 43% of service revenue and will soon be the only service to be carried on its own network so is still likely the most profitable. Mobile services declined 5.3% in the first quarter after declining by 8.1% in 2018. Although M1 is no longer listed and therefore we don’t have full market statistics, StarHub has been losing mobile market share over the past few years as its previously strong bundling strategy has been unravelling. This has mainly been due to the weakness in its pay TV business and the ability of its smaller competitor, M1, to bundle broadband with its service. Management expects a continued small decline in average revenue per quarter in mobile over the next few quarters with stability towards the end of the year.

StarHub’s pay TV also continued its decline with customers falling by 15,000 over the quarter to 394,000, having declined from 545,000 at the peak in the first half of 2015. Revenue was down 12.4% compared with 2018’s full-year rate of 11.9%. Netflix was launched at the beginning of 2016 and Singapore has a high rate of fibre broadband connections in Singapore with video piracy also reportedly very high. StarHub management admitted at the third-quarter result that the business model “was broken” with content producers going direct to customers over the Internet but still expecting pay TV providers to sign onto fixed deals for content. Once the pay TV providers are able to switch their deals to reasonable, variable deals, then they could compete against the over-the-top providers that provide video services over the Internet. The company is over half-way through negotiating lower-priced, variable deals as content deals expire and this is being helped by some of the content providers themselves going directly into the market. StarHub is also well over half-way through migrating its cable customers from its own cable network over to the national broadband network and has a target date of end June 2019 to finish this which should allow it to take out some operating and maintenance costs and help mild earnings recovery towards the back end of our five-year forecast period.