Growth surprises, capital management could be next

2QCY07 results marked the start of re-rating for Singapore telcos. Earnings for SingTel’s Singapore operations and M1 surprised on the upside while StarHub’s performance was within our expectations. The sector’s 9.5% yoy revenue growth, driven by double-digit increases in mobile (11.5% yoy) and Internet/data services (+14% yoy), was the quarter’s highlight.

Topline drivers remain a robust domestic economy and immigration influx. A robust domestic economy has lifted mobile postpaid ARPU (+5.6% yoy) and penetration rates for household broadband (Jun 07: 71%, Jun 06: 56%). Meanwhile, an influx of immigrant labour on the back of Singapore’s transformation into a global city continued to drive mobile-subscription growth (+11.5% yoy), despite high penetration rates of 111%.

Potential yield surprises. Consensus is expecting an average CY08 yield of 5.6%. We are going for 8.0%. We believe that topline-led cash-flow growth will set the stage for upside yield surprises over the next two years, particularly for StarHub and M1.

Risks receding. The risk of cost pressure is declining on the back of healthy topline growth. The three telcos are indicating greater comfort with next-generation broadband network (NBN) risks from a year ago, following dialogues with the regulatory body, IDA. We also believe the IDA’s final decisions will be balanced between introducing greater innovation through competition and limiting the risk of destructive competition for SingTel and StarHub.

Upgrading sector to Overweight from Neutral; SingTel our top pick on 3-6-month view; StarHub our preferred pick on 6-12-month view. We raise our target prices for SingTel (Outperform), StarHub (Outperform) and M1 (Neutral) as we roll forward our valuation to CY08. Our ratings on the three stocks remain unchanged. SingTel’s target price goes up to S$4.54 (from S$4.27), StarHub’s to S$3.64 (from S$3.50) and M1’s to S$2.40, all based on DCF valuations. Singapore’s telco sector is benefiting from strong consumption growth on the back of an immigration boom and robust domestic economy. Strong cash flow-generation sets the backdrop for attractive sector yields of 8%. SingTel is our top pick for nearterm outperformance, as it is most likely to benefit from fund flows seeking a safe haven together with high growth in regional markets. StarHub is our preferred pick for the medium term. As the leading quadruple-offering operator, StarHub arguably offers the best exposure to Singapore’s immigration boom, with a 10% yield on strong free cash flow. M1 is a pure defensive stock with prospective yields of 9.5%.

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