TELCOs – CIMB

Reading the signals for 1Q11

Maintain UNDERWEIGHT. We remain UNDERWEIGHT on the Singapore telco sector in view of cost pressures (albeit not as strong as 2010), weakness in fixed broadband and also the potential for multi-year margin erosion. We leave our earnings forecasts and target prices intact. M1 remains our top pick, for having the most upside from NGNBN and the most benefits from soaring inbound visitors, in our opinion. We continue to prefer Axiata and XL Axiata for exposure to regional telcos.

1Q11 themes. We broadly expect: 1) service revenue growth to be muted, in line with seasonal trends; 2) EBITDA margins to improve towards the tail end of the iPhone craze and also from lower advertising and marketing revenue; 3) data to continue replacing voice revenue; and 4) weakness in fixed broadband though stability in pay TV.

Data to continue replacing voice. We believe data revenue should climb further to replace voice revenue as smartphone penetration deepens and take-up of data packs grows as subscribers access emails and social networks on the go. Non-SMS data now accounts for 18-19% of M1’s and SingTel’s revenue (StarHub does not provide breakdown) while 33-40% of revenue from the three telcos comes from data (including SMS). This has also resulted in the cannibalising of voice traffic.

Margins to recover. Coming out of the festive period, we believe margins should improve as we see deflating subscriber acquisition costs in a traditionally slower period. In addition, the tail end of the iPhone craze and lower subsidies offered for devices should alleviate the pressure on margins.

Expectations for M1. M1’s core profit is expected to be S$38m-39m in 1Q11, up 1-4% qoq. We expect revenue to weaken as handset sales fall though service revenue should rise 1-2% qoq. We expect margins to recover from lower advertising and marketing costs and as device subsidies drop from lower pricing points and lower subsidies provided. M1 is expected to release results on 15 Apr.

Expectations for StarHub. We expect -3% to +4% qoq earnings growth for StarHub on margin improvements as lower subsidies prevail and also from lower advertising and marketing spend. We expect mobile revenue to rise on higher data take up as well as wireless broadband growth. However, fixed broadband revenue should be weak from lower ARPU net adds and as StarHub reached more of the lower-income group. Meanwhile, pay-TV revenue should be flat sequentially. StarHub is slated to release results on 4 May. We will be previewing SingTel’s results separately.

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