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.

Hopes for margin improvements

• In line; maintain UNDERPERFORM. 1H10 core profit matched our forecast at 46% of our FY10 figure but was below consensus (43%). We expect stronger quarters ahead as the initial flood of iPhone subsidies should dissipate, higher ARPUs from smartphones should begin to offset subsidies in subsequent quarters and Barclays Premier League (BPL) costs come off the books in 2H10. As expected, a 5-ct DPS was declared. We keep our earnings forecasts and DCF-based (WACC 9.7%) target price of S$2.14. We still expect de-rating catalysts from pressure on broadband ARPUs ahead of the NGNBN launch and potentially higher churns in pay TV following the loss of its BPL rights to SingTel. We prefer M1 for exposure to Singapore telcos for its potential capital management and our view that M1 will be the biggest beneficiary of NGNBN.

• Revenue rose 2% qoq and 7% yoy, led by strong performances in pay TV and postpaid, offset by lower equipment sales from lower handset volumes and a slight decline in prepaid revenue qoq. Thanks to the 2010 World Cup rights, pay-TV revenue rose a strong 8% qoq. Excluding this, revenue would have been down 1% qoq. Postpaid revenue grew 4% qoq, driven by roaming and IDD as well as rising contributions from data.

• EBITDA improved. As guided, EBITDA margins improved 1.4% pts qoq because of lower iPhone-subsidies. Margins, however, were dampened by one-off World Cup costs as well as higher content renewal costs which caused cost of service to rise 16% qoq. Marketing costs were also higher (+9.4% qoq), related to the World Cup.

• No change to 2010 guidance. StarHub has kept its guidance of low-single-digit growth in revenue despite a 6% yoy rise in 1H10 so far. It is conservative as pay-TV revenue could decline following the loss of BPL going forward. There was no change to its service EBITDA margin guidance of 28% despite 1H10’s 25% as it expects a higher ARPU uplift from smartphones to overcome handset subsidies provided for them. Also, the heavy loss-making BPL content cost would come off the books in 2H10. Also, no change to the minimum 20 cts/share DPS guidance or cash capex not exceeding 14% of revenue.