M1 – DMG

Value emerges

Stock slides. Since our last note on M1 on 20 Oct 08, the stock has dived 26% on the back of weak sentiments in the market, as well as negative newsflow from the telecommunications industry. The other two telcos, particularly SingTel, painted a bleak outlook for the next few quarters. Consequently, despite the fact that the industry is largely seen to be defensive, the telco index FSTTC fell by 8% in the past month. Before the recent slump, M1 has been one of the most resilient stocks. It only fell 4% for the first nine months of the year, far outperforming the STI’s 32% slump.

Recapping results. While M1’s revenue fell a mere 1.7% to S$196.7m in 3Q08, earnings took a bigger 21.1% knock to S$34.4m due to higher acquisition and retention costs, following the introduction of mobile number portability in Jun 08. EBITDA margin came in at 42.5%, down from last year’s 45.2%. Gearing, at 128.2%, is seemingly high for M1. But this is not very much of an issue, considering that it has strong operating cash flows that will enable it to comfortably pay off its debts and reward shareholders. It has a Net debt/EBITDA of 0.8x (SingTel 1.1x, StarHub 1.2x), while its EBITDA/Interest stands at 40.6, an improvement over the previous year’s 33.1.

Recession’s not the main curse. Looking back at the past recessions, management revealed that the bad debts are quite insignificant – less than 0.5% of revenue. What investors need to be more worried about is competition. The aggressive marketing by all three telcos have led to surging subscriber acquisition and retention costs, and consequently margins being driven down. Our recent discussions with the telcos suggest that this intense competition will be dying down, at least for now.

Churn rate eased. In 3Q08, M1 was hit with a high churn rate of 1.8%, a jump from 1.2% in the previous corresponding period due primarily to SingTel’s launch of the iPhone. This should be reduced to the 1.5% level as competition tames.

Target price down, but value emerges. We have left our earnings estimates at S$160.1m for FY08 (-6.8% YoY) and S$149.1m for FY09 (-6.9% YoY). At S$1.25, it is trading at 7.0x FY08 and 7.5x FY09 P/E, which compares favourably against the industry average of 9.4x. The yields, at 12.2% for FY08 and 11.4% for FY09, are also the best among the three telcos. We have downgraded our target price for M1 from S$1.89 to S$1.58, based on our revised DDM model. We are upgrading the stock to a BUY despite cutting the target price, as it is looking attractive after the recent fall with a potential upside of 26% from current levels.

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