Below expectations: guidance for 2010E mixed; revenue slowdown

What surprised us

Starhub (STH) reported 4Q09 service revenue, EBITDA and net profit of S$521 mn, S$152 mn, S$74 mn: +1%, -7%, -14% yoy and 0%, -7%, -6% vs GSe. Key deviation from our estimates is on mobile SAC as STH introduced iPhone in December. Positives: a) sub adds pickup – broadband, cable TV and post-paid mobile adds all improved sequentially, the latter due to iPhone; b) churns remain manageable – pay TV churn is roughly flat qoq and broadband churn has fallen qoq, despite rivals getting more aggressive on both access and pay TV ahead of the NBN launch. Negatives: a) accelerating declines in broadband revenue – 4Q09 revenue was -8% yoy vs -3%/-6% for 2Q09/3Q09, due to ARPU declines; b) fixed network revenue trends also weakened, to +2% yoy vs +6-8% yoy the prior three quarters. We do not view higher SAC from iPhone as a negative necessarily as mgmt believes payback period is 2-6 months in Singapore and subscriber quality will improve, but would look for validation on returns in terms of ARPU /revenue pickup in coming quarters. Guidance for 2010E: 1) revenue growth of low single digit (vs I/B/E/S est flattish); 2) service margin of 30% (excl equip and Opco grant) (slightly lower than consensus of 31%); 3) capex not to exceed 14% (vs prior guidance/consensus of 13%); 4) S$0.05 DPS/quarter (unchanged).

What to do with the stock

We think STH faces meaningful operational headwinds/risks from NBN and pay TV and earnings/CF visibility is reduced. But, we believe 9% yield provides downside support. We prefer Mobile One (M1) in Sing telco space for its similar valuation/yield but offensive position / potential for mobile/NBN revenue share gains. We revised STH earnings by -13%/+15%/+13% in ’10E/11E/12E mainly to reflect iPhone/NBN upfront cost in ’10E and back-loaded benefits starting from 2011E. 12-m DCF TP is S$2.15 (from S$2.13). Still Neutral. Risks: Downside: broadband/pay TV share loss; Upside: b-t-e sub retention post NBN launch and EPL loss.

Potential profit-margin squeeze ahead of NGNBN

What has changed?

• StarHub held an investor conference call on 4 February for its FY09 results.

Impact

• StarHub’s FY09 net profit was slightly below our and the market’s expectations, mainly due to the festive-season promotion and the launch of the iPhone in early December, which drove equipment costs higher by 67% YoY in 4Q09, offsetting cost-saving efforts in the first three quarters in 2009.

• StarHub guided for ‘low single-digit’ revenue growth in FY10, a service-EBITDA margin of around 30%, and a capex-to-revenue ratio of not more than 14%, which would lead to higher depreciation of around 13% of operating revenue. We have revised down our net-profit forecasts by 12% for FY10-11, mainly to factor in the higher depreciation charge.

• Although the high-level of coverage of NGNBN (Next Generation National Broadband Network) could expand StarHub’s corporate coverage nationwide while the low wholesale price of the OpCo (operating company) could lead to saving in leasing expenses, it could lead to heightened competition, particularly in the broadband segment ahead of the network rollout, and erode the company’s profit margin.

Valuation

• We lowered our six-month target price to S$1.92 (from S$1.99), equivalent to a PER of 11x our revised FY10 EPS forecasts, on par with StarHub’s Singapore telecom peers. The stock is now trading at 12.4x our FY10E EPS, a 5% discount to the average valuation for regional integrated operators.

Catalysts and action

• StarHub shares rose by about 3% one week ahead of the company’s results, due to what we think was an expectation of a positive 4Q09 earnings surprise. We believe the weaker-than-expected 4Q09 earnings (down 15% YoY), together with unexciting FY10 guidance, could create short-term pressure on the shares.

• Considering StarHub’s attractive dividend yield of 9.2% for FY10-12E, its valuation (12.4x FY10E EPS) appears undemanding. Nevertheless, SingTel’s (ST SP, S$2.98, 3) aggressive stance in the pay-TV market, which is the core of StarHub’s convergence strategy, could reduce the defensiveness of StarHub. Therefore, we maintain our 3 (Hold) rating.

Downgrade to Neutral

• Share price has recovered after the initial concern over loss of EPL content

After the sharp fall following the announcement that StarHub lost the rights to English Premier League (EPL) football content, StarHub shares have now recovered to previous levels as management increased dividends (Chart 1). In the past 3 months, StarHub shares are up 15% outperforming FSSTI by 12%.

• Q409 results and 2010 guidance below consensus forecasts

Q409 results were below our expectations and consensus as wireless and cable margins were pressured due to iPhone introduction and competition. StarHub guided for low single-digit revenue growth and 30% EBITDA margin in 2010. This implies EBITDA of about S$620-640mn, which is in-line with our forecast of S$633mn but below consensus of S$657mn. The guidance implies YoY decline in EBITDA margin from 31.8% in 2009. StarHub expects pay TV content cost to remain high despite the loss of EPL due to the cost to secure other contents.

• Dividends should provide some share price support

We think robust cash flows and balance sheet should help sustain S$0.05 dividend per share per quarter, which should provide some share price support. But EPL content loss and NBN launch would lead to StarHub losing market share in the consumer segment, which should negatively impact investor sentiment.

• Valuation: Downgrade to Neutral from Buy; Maintain S$2.20 price target

Reflecting Q409 results and 2010 guidance, we slightly adjust our 2010/11 EPS forecast to S$0.177/0.183 from S$0.182/0.179, respectively. Our price target is based on DCF using 7.8% WACC and 0% terminal growth.

Strong dividends, attractive value

StarHub reported in-line FY09 profit at S$320m. It maintained its dividend commitment at 20 cents for FY10, outlining its confidence in its business stability. This leads to what we see as a healthy 9% yield, while the stock trades at an attractive 11.8x PER. Buy maintained.

In-line FY09 performance

StarHub reported FY09 profit of S$320m (up 3% yoy), in line with RBS (S$322m) and street (S$324m) estimates. The company met estimates despite 4Q09 margins declining 290bp yoy, due to the temporary rise in marketing/subsidy spend in 4Q09 linked to its iPhone launch.

Performance drivers: stable mobile, pay TV, weaker broadband

Performance was driven by sequentially stable/improving ARPU in the mobile business (51% of revenues) with the improvement in the economy and rising data contributions. Pay TV (19% of revenues) also improved. However, performance was dragged down by weaker cable broadband contributions (11% of revenues) as a result of price cuts as competition intensified ahead of the NGNBN launch.

FY10 guidance: slight revenue growth but tighter margins, strong dividends

StarHub has guided for low single-digit revenue growth for FY10, driven by expansion in mobile contributions. This compares to the street’s expectations of flat top-line growth. Management has committed to dividends of at least 5 cents a quarter for FY10, allowing for a 9% yield. However, it guided for FY10 EBITDA margins to tighten to around 30% from 31.8% in FY09. This is in line with our expectations as broadband revenues are impacted by the NGNBN launch.

Buy maintained; undemanding value, strong yield, stable outlook

We continue to rate StarHub a Buy with a DCF-based target price of S$2.45. The company remains relatively cheap, in our view, at 11.8x FY10F PER and 6.8x EBITDA. It is yielding an in-our-view attractive and sustainable 9% for FY10-12.

4Q09 below DBe on weak margins but yield sustainable

4Q09/FY09 profit below DBe but Buy for the yield

STH’s S$74m 4Q09 NPAT was below our S$78-80m forecast as mobile margins compressed to recent lows on the iPhone launch. As a result, FY09 total profit at S$320m was S$9m/3% below DBe. But FY09 free cash flow at 27c/share was better than expected and STH is still targeting a minimum FY10e 20c/share dividend – a target we view as achievable even given FY10e capex guidance. We therefore maintain Buy for the 9.2% yield and STH is our preferred S’pore telco.

4Q09 margin weakness distracts from good revenues

The key 4Q09 theme was the significant mobile margin compression which drove total EBITDA down 12% QoQ and 8% YoY to S$152m giving a 27.7% margin (the lowest since 2Q08). There was similar substantial compression in fixed margins. But this margin weakness masked strong revenue performance with both 4Q09 total and service revenues hitting new quarterly highs primarily on good mobile performance, e.g. the best post-paid mobile net adds since 3Q08 and mobile ARPU stabilization. 4Q09 service revenues were up 1.3% YoY to S$521m and the S$2,150m total FY09 revenues were slightly ahead of DBe.

4Q09 NPAT lowest since 2Q08 but dividend stable

As expected, STH’s 4Q09 profit benefited from a net tax credit adjustment but even so, the S$74m profit was down 15% YoY and 13% QoQ. Total FY09 profit at S$320m was up 3% YoY giving 18.7c EPS. But the 27c FCF/share is significantly ahead of the FY09 dividend per share and the company remains committed to its FY10e 20c/share dividend target. Given STH’s balance sheet, this is achievable despite guidance for FY10e capex to increase to 14% revenues (DBe 13%). Furthermore, management is more confident than DB on revenue outlook with FY10e revenue growth guidance set at “low single digits” versus DBe’s -3%.

Maintain Buy as still our preferred S’pore telco

We maintain our S$2.35 target price. Our valuation is based on DCF (7.2% WACC, 0% g) and our target price implies an 8.5% yield at a target 12.4x FY10e PE. Given the 8% upside to our target price and 9% sustainable yield, we reiterate Buy and STH remains our preferred S’pore telco and one of our recommended Asian yield telcos. Risks primarily relate to content costs and competition