2Q FY10: largely in line; earnings visibility remains poor

● StarHub’s 2Q FY10 operating performance was largely in line with our expectations. 2Q revenue of S$569 mn (+7% YoY) was 2% above our forecast (of S$556 mn) while EBITDA of S$141 mn and net profit of S$58 mn were 4% above our expectations (of S$135 mn and S$56 mn, respectively).

● Looking ahead, management maintained its full-year revenue growth guidance at low single digit and EBITDA margin at 28%. The company also maintained its minimum dividend of S¢5 per quarter for FY10 and management reiterated that the current level of dividend is sustainable. Taking the view that margins in 2H would improve, we fine tune our FY11/12E EPS by 1%.

● We maintain our view that the company’s earnings visibility will continue to be impacted by the more intense competitive landscape. Notwithstanding the attractive dividend yield of 8.6% for FY10 and the stock’s recent underperformance, we maintain our UNDERPERFORM rating. Our DCF-based target price of S$2.05 implies 12% potential downside from current levels.

2Q results largely in line with our expectations

StarHub reported 2Q10 results on 5 August. Its operating performance was largely in line with our expectations. 2Q revenue of S$569 mn (+7% YoY) was 2% above our forecast (of S$556 mn)

while EBITDA of S$141 mn and net profit of S$58 mn were 4% above our expectations (of S$135 mn and S$56 mn, respectively). The 7% YoY growth in overall revenue was driven by a 10% rise in post-paid mobile revenue and a 9% rise in pay-TV revenue. The former was due to the growth in its post-paid subscriber base to 994,000 (from 910,000 in 2Q FY09). However, with COGS surging 26% YoY to S$251 mn, 2Q EBITDA fell 12% YoY (to S$141 mn) and 2Q net profit contracted 25% (to S$58 mn). In addition to a 65% YoY jump in cost of equipment (to S$81 mn), cost of services rose 21% YoY, as a result of higher pay-TV content costs during the period.

Higher mobile data usage offsets lower voice usage

While non-voice usage expanded further (to 34.6% of post-paid ARPU from 30.5% a year ago), voice minutes continued to fall (-12% YoY). As such, ARPU improved just 1% to S$70 (from S$69 during the same period last year). This supports our view that growth in data usage should help offset the decline in voice ARPU, rather than boost overall mobile ARPU. As highlighted in our Asia telecoms sector report, Smartphones – a welcome revenue boost, published on 2 February 2010, we expect overall Singapore mobile revenue to achieve a CAGR of 2% between 2009 and 2015. The corresponding growth rates for voice and data revenue are -4% and 19%, respectively. Driven by higher smartphone sales, acquisition costs per sub rose 38% YoY to S$109 (but fell 11% from S$122 in 1Q10). StarHub added 28,000 post-paid (1Q: 27,000) and 53,000 pre-paid (1Q: 30,000) subs during the quarter.

Looking ahead, management maintained full-year revenue growth guidance at low single digit (in view of the potential impact from the loss of Barclay’s Premier League broadcasting rights on pay-TV subs and the launch of the New Generation National Broadband Network in 3Q10) and EBITDA margin at 28% (versus 30% in 2009). StarHub is also maintaining its minimum dividend of S¢5 per quarter for FY10 and management reiterated that the current level of dividends is sustainable. StarHub’s 1H revenue and EBITDA accounted for 51% and 45% of our full-year forecasts, respectively. Taking the view that margins in 2H would improve, we marginally fine tune our full-year forecasts.

Maintain UNDERPERFORM

We maintain our view that the company’s earnings visibility will continue to be impacted by the more intense competitive landscape. Notwithstanding the attractive dividend yield of 8.6% for FY10 and the stock’s recent underperformance, we maintain our UNDERPERFORM rating. Our DCF-based target price of S$2.05 implies 12% potential downside from current levels.

Q210 results disappoint; Retain Sell rating

• Margin recovery in Q210 less than expected

iPhone launch dragged down StarHub’s earnings in Q1 and we had expected earnings to recover in Q2 as iPhone sales slows. While net profit did jump from S$42mn in Q1 to S$58mn in Q2, it was well below our expectation of S$72mn and Bloomberg consensus of S$69mn.

• Weak subscriber trend for pay TV and broadband

Postpaid was the bright spot in Q2 as StarHub recorded wireless postpaid net adds of 29,000 and postpaid revenue increased 10% YoY and 4% QoQ. But for broadband and pay TV, StarHub recorded zero net adds in Q2 (Table 2). Churn rate for broadband increased to 1.6% from 1.2% in Q1 and churn rate for pay TV increased to 1.2% from 0.9% in Q1.

• Further challenges in H210

In H210, we expect StarHub’s wireless profits to be pressured again as iPhone 4 was launched in July. And we expect market share to be pressured as on the pay TV side StarHub has lost BPL content to SingTel and on the broadband side there will be new entrants through NBN.

• Valuation: Retain Sell rating and S$2.05 price target

The 8.6% dividend yield is the only support for StarHub share price, in our view. However, we recommend the Taiwan telcos over StarHub for investors seeking defensive dividends in Asia. Reflecting weaker than expected Q2 results, we cut 2010/11/12 EPS forecast to S$0.144/0.172/0.174 from S$0.156/0.172/0.175, respectively. Our price target is based on DCF using 7.8% WACC and 0% ‘g’.

Q210 results disappoint; Retain Sell rating

• Margin recovery in Q210 less than expected

iPhone launch dragged down StarHub’s earnings in Q1 and we had expected earnings to recover in Q2 as iPhone sales slows. While net profit did jump from S$42mn in Q1 to S$58mn in Q2, it was well below our expectation of S$72mn and Bloomberg consensus of S$69mn.

• Weak subscriber trend for pay TV and broadband

Postpaid was the bright spot in Q2 as StarHub recorded wireless postpaid net adds of 29,000 and postpaid revenue increased 10% YoY and 4% QoQ. But for broadband and pay TV, StarHub recorded zero net adds in Q2 (Table 2). Churn rate for broadband increased to 1.6% from 1.2% in Q1 and churn rate for pay TV increased to 1.2% from 0.9% in Q1.

• Further challenges in H210

In H210, we expect StarHub’s wireless profits to be pressured again as iPhone 4 was launched in July. And we expect market share to be pressured as on the pay TV side StarHub has lost BPL content to SingTel and on the broadband side there will be new entrants through NBN.

• Valuation: Retain Sell rating and S$2.05 price target

The 8.6% dividend yield is the only support for StarHub share price, in our view. However, we recommend the Taiwan telcos over StarHub for investors seeking defensive dividends in Asia. Reflecting weaker than expected Q2 results, we cut 2010/11/12 EPS forecast to S$0.144/0.172/0.174 from S$0.156/0.172/0.175, respectively. Our price target is based on DCF using 7.8% WACC and 0% ‘g’.

Good cash flow but earnings disappoint

At a Glance

• Net earnings of S$58m disappoints, as content costs increase and handset subsidies continue

• Free cash flow better than expected however, as capex of S$45m well below quarterly run-rate, plus working capital stays in positive territory

• Dividend payout of 5.0Scts, as guided; we remain skeptical on dividend sustenance beyond FY10

• Maintain Fully Valued call at TP of S$2.20

Comment on Results

While 2Q10 earnings of S$58m (up 36% q-o-q, down 25% y-o-y) recovered on a sequential basis, it still fell short of our expectation of around S$65m, largely because of higher than expected content costs of S$103m (up 21% y-o-y, 16% q-o-q), arising from the production costs and broadcast rights for the FIFA World Cup in June 2010, among others. Handset subsidies for iPhones continued to push up costs on a y-o-y basis as well, though equipment costs declined by about S$12m from 1Q10 levels. Mobile market share improved to 29.2% in 2Q10 from 28.4% in 1Q10.

Going forward, we continue to expect earnings recovery in 2H10, owing to lower handset subsidies and absence of one-off costs, and maintain our earnings estimates for FY10. Management continues to guide for i) low single digit revenue growth ii) 28% service EBITDA margins, and iii) a capex to sales ratio of up to 14%.

Recommendation

Low capex of S$45m in 2Q10 led to better-than-expected free cash flow of S$110m for 2Q10. An increase in payables for handsets also rendered working capital positive, boosting FCF. However, we believe a back-end loaded capex will lead to declining FCF in subsequent quarters. We still expect FCF to fall short of dividend commitments in future – if not in FY10 – as StarHub is committed to S$100m capex for NBN over 2010-12. Thus, we maintain our view that the 20Scts annual DPS may not be sustainable. Maintain Fully Valued; our DCF-based TP is unchanged at S$2.20.

2Q10 Results

• 2Q10 revenue of S$569.3m, net profit of S$58.1m

• Higher costs of smart phones, Pay TV content costs, staff costs, marketing and promotion expenses as well as repair and maintenance expenses

• Upgrade from Sell to Hold and raise fair value from S$1.92 to S$2.16

2Q10 results

StarHub reported 2Q10 operating revenue of S$569.3m (+6.9% y-y) and net profit of S$58.1m (-25.4% y-y). Revenue was 4.9% higher than our estimate of S$542.6m while net profit was 16.8% lower than our estimate of S$69.9m. It also announced an interim dividend of S$0.05 per ordinary share for 2Q10, which was higher than S$0.045 for 2Q09. Revenue increased mainly because of greater mobile and Pay TV services revenue. Net profit dropped because of higher costs of smart phones, staff costs, marketing and promotion expenses as well as repair and maintenance expenses. Furthermore, Pay TV content costs rose due to the broadcast of the FIFA World Cup 2010.

FY2010E Outlook

There is no change to StarHub’s expectation that the operating revenue growth for 2010 will be in low single digit. Furthermore, it expects to pay dividend of S$0.05 per ordinary share per quarter for this year. Moreover, it anticipates stiff competition in mobile, broadband and Pay TV for 2H10.

Upgrade from Sell to Hold and raise fair value from S$1.92 to S$2.16

As StarHub reported an improvement of 2.2% and 36.1% in 2Q10 revenue and net profit respectively compared to 1Q10 revenue of S$557.2m and net profit of S$42.7m, we upgrade our recommendation from sell to hold. We also raise its fair value from S$1.92 to S$2.16 based on the discounted cash flow (DCF) model. However, we continue to have doubts that it can sustain its dividend payout of S$0.05 per quarter in the long-term. This is because its earnings per share of S$0.0585 for 1H10 are less than the total dividends of S$0.10 for the same period.