Single-digit growth ahead + 6.5% yield

At a Glance

• 1Q09 net profit was above expectations mainly due to lower depreciation charges.

• Market may be disappointed, as M1 did not announce capital management. Management would review capital structure in 2Q10 though.

• Our FY10F/11F earnings are raised by 4%/7% on the back of upbeat guidance from management.

• Any share price weakness should be a buying opportunity. BUY with revised TP of S$2.28.

Core earnings growth of 8% yoy. 1Q10 net profit of S$39.3m (-6% yoy, +6% qoq) was better than our expectations of S$37m. Excluding one-off tax credit of S$5.5m in 1Q09, it represents 8% yoy core earnings growth in 1Q10. The quarter benefited from lower depreciation expenses of S$27.7m (-11% yoy, -16% qoq) as some assets had fully depreciated in 2009.

Improved market share for the fifth consecutive quarter. Mobile market share stood at 25.8% (versus 25.7% in 4Q09 & 25.2% in 1Q09) as prepaid mobile subscriber share improved while post-paid market share was stable. Churn rate declined significantly to 1.4% (1.6% in 4Q09 & 1Q09 each), lowest ever since introduction of mobile number portability in 2008.

Capital management disappointment. M1 did not announce capital management citing working capital requirements, which stood higher in 1Q10, potentially due to more iPhones sold under the “Take 3” program. M1 intends to review capital structure in 2Q10 after considering working capital requirements.

Growth prospects emerge for FY10F and beyond. Management guided for improvement in FY10F earnings compared to stable earnings guidance earlier. This could be attributed to lower depreciation charges. FY11F and FY12F earnings should benefit from (i) National Broadband Network launch in 2H10F and (ii) content-sharing regulations paving the way for its pay TV entry. Our TP is based on 13x FY10F PER (historical average 12x) due to better growth prospects.

M1 posts 6% dip in Q1 profit

Telco revises its earnings expectations for 2010 upwards

M1 LIMITED posted a 6 per cent year-on-year decline in net profit for the first quarter of this year, from $41.9 million to $39.3 million.

Excluding a tax adjustment that had boosted Q1 2009’s bottom line, M1’s net profit for Q1 2010 saw an increase of about 8 per cent.

Revenue for the quarter ended March 31 increased 33.6 per cent from $186.4 million to $249 million on the back of higher service revenue and handset sales.

Compared with Q4 2009, revenue grew 15.1 per cent, predominantly driven by handset sales.

Both postpaid and prepaid revenue increased in Q1, growing 1.3 per cent and 8.5 per cent year on year due to an expanding customer base.

For the quarter, M1 gained 38,000 customers, out of which 21,000 were postpaid customers and 17,000 were prepaid customers.

This took its customer base to 1.796 million as at end-March, an increase of 10.9 per cent year on year.

At end-February, M1’s market share held steady at 25.8 per cent, compared to 25.7 per cent in Q4 2009.

‘We expect data usage to continue to grow due to the take-up of smartphones,’ said Karen Kooi, chief executive officer of M1.

‘We are looking forward to the commercial launch of the Next Generation Nationwide Broadband Network and plan to offer a comprehensive suite of services for homes and offices. We will continue to upgrade our High-Speed Packet Access (HSPA) network to support downlink speed of up to 42Mbps by 2010 as well.’

In response to questions about its opinion on the allocation of the remaining 3G spectrum, M1’s chief technical officer Patrick Scodeller said: ‘We are in the process of replying to the Infocomm Development Authority of Singapore (IDA) and generally our view is that we would like some of the spectrum to support our growth in 3G.’

The IDA is currently seeking views from the telecom industry and the public about its proposal to free up its remaining 3G cellular spectrum and perhaps allow a fourth operator into the high-speed mobile services playing field.

The modernisation of its 2G network remains on track for completion in Q1 2011.

M1 also revised its expectations of earnings for the year upwards.

‘We are estimating full-year earnings as likely to improve compared to 2009,’ said Ms Kooi.

During the release of M1’s Q4 2009 results, the group had stated that it expected earnings in 2010 to be ‘comparable’ to 2009.

Earnings per share for the quarter fell 6.4 per cent from 4.7 cents to 4.4 cents, year on year.

The counter rose three cents in trading yesterday, to close at $2.14.

1Q FY10 preview: higher sales; marginally lower EBITDA

• M1 will report its 1Q FY10 results after the market closes on Friday this week. We are looking for 1Q FY10 revenue to grow 16% YoY to S$216.2 mn, driven mainly by higher handset sales and fixed network revenues. We expect the arrival of compelling smartphone models, including the iPhone, to drive handset sales.

• However, higher handset sales could drive margins lower for the quarter. At the EBITDA level, we are looking for a 1% YoY decline in 1Q earnings to S$76 mn.

• During the FY09 results briefing, management mentioned that it would review its capital structure once refinancing of the S$250 mn loan was completed. The completion of the refinancing exercise late last month should pave way for a capital structure review – potentially a higher/special dividend payout. We look forward to management's guidance on any capital structure review at the post-results conference call this Friday.

• We maintain our OUTPERFORM rating on M1 with a target price S$2.60. This represents 24% upside from current levels.

Maintain cautious stance and Hold rating with new S$2 TP

New S$2 TP on fixed-line upside but still cautious on fundamentals, Hold

We include potential fixed-line upside into our M1 estimates, which raises our TP 25% to S$2. But M1’s fundamental outlook remains challenging and we caution against excessive optimism that the National Broadband Network will significantly alter M1’s competitive positioning or growth profile. M1’s late entry into a mature fixed-line market entails substantial execution risks while near-term margins are under pressure. M1 remains our least preferred Singapore telco. But the potential for capital return should provide near-term price support, hence maintain Hold.

Late-entry into fixed-line market presents significant execution risks

M1 is likely to face an uphill task in gaining significant scale as a late entrant into a mature fixed market. With limited service differentiation, it is difficult to see how M1 can encourage significant subscriber churn from STel and STH, unless it is willing to sacrifice margins by competing aggressively on price (a strategy management has indicated to us they will not pursue). We are cautious of substantial NBN execution risks and are not particularly convinced it will significantly improve M1’s competitive positioning and growth profile. Furthermore, the growing emphasis on fixed-line could become an increasing management distraction and impact M1’s performance elsewhere.

Revenue estimates raised but margins now assumed to compress harder

With the impending NBN launch, we now include estimates for M1’s fixed-line business into our forecasts. This raises our FY10e-12e revenue projections 8-19%. But we assume greater margin compression than previously assumed (on costs of developing fixed-line services and expected increase in NBN-driven competition) and project FY10e EBITDA margin to fall 1.5% pt YoY, causing net profit to flat-line (in-line with management guidance). Our FY10e-12e forecasts are 2-11% below Consensus estimates, largely due to our lower margin expectations.

DCF-derived TP; key risks include competition and fixed-line execution

Our TP is raised to S$2 (+25%), primarily reflecting the potential upside from M1’s fixed-line business (which we now include in our estimates). Our TP implies 12.2x FY10 PE. We value M1 using DCF analysis based on 7.2% WACC and 0% terminal growth rate reflecting the long-term ex-growth nature of Singapore’s telco market. Key risks include competition, fixed-line execution and capex