Decent 2QCY11 scorecard; maintain OVERWEIGHT

Decent 2CY11 showing. All the three telcos – M1, SingTel and StarHub – put in pretty decent showing in their 2QCY results recently, mostly meeting our forecasts, and largely demonstrating the defensive nature of their businesses. Both M1 and StarHub declared an interim and quarterly dividend of S$0.066/share and S$0.05, respectively.

Review of Singapore operations. SingTel continues to dominate the local telecoms market, with a ~46% share in the post-paid mobile market, followed by StarHub with ~28% and M1 ~26%. Collectively, we note that the post-paid subscriber base here grew by around 90k QoQ to 3912k; M1 added 13k, SingTel +57k, and StarHub +20k in the last quarter. And with the bulk of the phones sold continuing to be smartphones, we also see higher contribution from data as a percentage of post-paid ARPU (min of 36% for StarHub to a max of 41% for SingTel), although monthly ARPUs have already stayed largely flat at S$55 for M1, S$87 for SingTel and S$73 for StarHub. The broadband segment was generally quite lackluster for all the three telcos, hampered by the slower than-expected take-up of the new Fiber plans under NBN (National Broadband Network) initiative. The Pay TV segment for both SingTel and StarHub continued to show modest growth as households are increasingly getting used to the idea of having two set-top boxes.

2H11 outlook remains stable. Going forward, all the three telcos expect their Singapore operations to remain stable or show modest growth, buoyed by continued customer additions and increasing mobile data usage; note that StarHub though has nudged its revenue growth to low single-digit from single digit previously. We expect the three telcos’ EBITDA margins to remain around current levels – 42% for M1, 42% for SingTel and 30% for StarHub. Both M1 and SingTel have also kept their earlier capex guidances unchanged; but StarHub has pared its capex from 13% of revenue to 12%. And thanks to their strong cashflow-generative businesses, the telcos have largely kept their dividend payout guidance; M1 to pay at least 80% of underlying net profit; SingTel to pay 55-70% of underlying earnings; StarHub to pay S$0.20/share, or S$0.05/share per quarter.

Overweight on telcos. In light of the increased volatility in the market due to the unresolved uncertainties in Europe, the still floundering economic recovery in the US and potentially slowing economic growth in China, we continue to like the telcos’ defensive earnings and relatively attractive dividend yields. Maintain OVERWEIGHT. While we have BUY ratings on all three telcos, our preference is for M1 as we believe it has potentially the most to gain from the NBN in the coming two years.

Sector offers >6% yield, 2Q11 Review

• M1’s higher gearing and weak free cash flow may limit earnings payout to 80%, below last year’s 100%.

• SingTel continues to gain mobile revenue share while StarHub is gaining non-mobile subscribers despite absence of English Premier League rights.

• StarHub is our top pick, trading at 7.4% yield (fixed 20 Scts DPS) versus 6% for M1 & SingTel.

A quick recap of 2Q2011 results. M1 & StarHub reported inline earnings while SingTel’s earnings were 5% below our expectations. SingTel disappointed on lower than expected earnings contribution from Bharti and Optus. Bharti was hit by 3G rollout costs and higher tax rate in India. Optus, on the other hand, witnessed higher mobile competition as smaller player VHA joined market share battle with incumbent Telstra.

StarHub (Buy, TP: S$3.05) is our top pick. StarHub’s free cash flow is likely to be ~120% of FY11F earnings, as the company pays minimal cash tax due to its deferred tax assets. StarHub has a fixed dividend policy of 5 Scts per quarter for FY11F. We believe this will be maintained in the coming years.

StarHub impressed in the non-mobile segment. Despite loss of EPL and ESPN rights, StarHub continued to gain pay TV subscribers with sequentially stable ARPU. Moderate subscriber growth in the broadband segment and stable ARPU also demonstrated solid execution.

M1 (Hold, TP: S$2.60) may not gear up significantly above its peers. At the end of 2Q11, M1 had net debt to annualized EBITDA of 1.1x versus 0.7x for StarHub and SingTel each as shown in the chart on the side. M1’s gearing spiked from borrowing S$81m to partly pay for FY10 dividends, as its free cash flow was very weak. Even FY11F free cash flow may be ~70% of FY11F earnings due to fair value accounting for handsets. In our view, investor should expect 80% earnings payout ratio.

SingTel (Hold, TP: S$3.20) continued to gain mobile revenue share in Singapore. This was driven by more attractive lineup of handsets and devices offered slightly ahead of peers, focus on pushing data SIM cards by bundling them with fixed broadband service and attractive discounts to subscribers on re-contracting. Peers do not emulate these tactics lest market should become more competitive.