Author: kktan
TELCOs – Maybank Kim Eng
All in; SingTel raised to BUY
- Raise sector weighting to OVERWEIGHT as we upgrade SingTel to BUY. M1 remains our preferred BUY, followed by SingTel.
- M1 will enjoy stronger EPS CAGR of 8.5% over FY14E-16E, while SingTel is on the cusp of an earnings recovery of 5% EPS CAGR after three consecutive years of earnings decline.
- Growth pillars: Data monetisation and falling handset subsidies, with data roaming rebound a bonus.
Upgrade SingTel to BUY, sector to OVERWEIGHT
We upgrade SingTel to BUY with a SOTP-based TP of SGD4.35. We are now BUYers of all the three telcos, prompting us to raise the sector to OVERWEIGHT. In terms of preference, M1 remains our top choice, followed by SingTel which displaces StarHub to the third position. Despite challenges on the Pay TV and home broadband front, StarHub remains a BUY. We believe SingTel’s YTD under-performance and current low market expectations provide room for the stock to be re-rated ahead of StarHub.
Alignment of positive trends
In our view, the building blocks are fast falling in place and were evident in 1Q14 results. Data monetisation accelerated in 1Q14, driving mobile revenue to record levels with growth rate at its fastest in more than four quarters. Tiered data plan users have also hit new highs of more than 50%, and we expect 70% by year-end. Fast-falling handset subsidies are another positive trend that would benefit margins. Lastly, data roaming has finally stabilized after six quarters of YoY decline. The upshot: Stronger earnings growth prospects for the industry.
Catalysts: (1) Data monetisation could take place faster than expected with emphasis on video content to drive data usage. Both SingTel and StarHub are developing more local content for their apps. (2) Data roaming could make a comeback on plans to make it easier to activate or even kick in automatically when users are overseas. (3) Low levels of gearing, especially for M1 and StarHub, and the absence of large capex requirements in the medium term suggest room for higher dividends ahead.
Risks: As the telcos expand the capabilities of their networks to handle newer services such as VoLTE (Voice over LTE) and the greater demand for video content, there could be network outages. Regulatory fines aside, the key risk lies in higher user churn owing to unstable networks. One risk particular to SingTel is an acquisition of Shin Corp as was rumoured a few months ago, which we would view cautiously if it materialises.
Land Transport – CIMB
Cool winds of change
With changes to the public bus system just announced by the government, both CD and SMRT can expect to eliminate operating losses in this segment of their business and improve their cash flow through lower capex and asset disposals. Conventional thinking favours CD (Add, target S$2.59) as the biggest winner, owing to its larger bus fleet and experience with cost-plus models, but we think that SMRT’s (upgraded to Add, target S$1.67) performance will also improve, as this development could serve as a prelude to a new rail financing framework. We upgrade the sector to Overweight from Underweight, with catalysts from more government initiatives and SMRT as our top pick.
What Happened
The government is revamping Singapore’s public bus industry to a “government contracting model”, starting 2H14. Under the new system, the government will own all bus infrastructure (depots, buses and systems).
Implementation only in 2H16. Initially, LTA will tender out three packages of bus services (out of a total of 12), starting with the first package in 2H14, for implementation in 2H16. The three packages will cover 20% of the existing buses. LTA will negotiate with the incumbents to run the remaining nine packages (80% of existing buses) under the contracting scheme, for durations of about five years when their Bus Service Operating Licences (BSOLs) expire on 31 Aug 16. After their expiry, more bus services will gradually be tendered out. The contracts will be valid for 5+2 years.
What We Think
The devil is in the detail. Details of the first bus package will be out next week. After 2022, all packages will be tendered out, with the aim of having at least 3-5 bus operators in the market. While some numbers regarding margins, the transfer of assets to the government and contracting are not out yet, we have made certain assumptions for CD and SMRT, to estimate the impact on their earnings, balance sheets and fleet-disposal plans to reflect these landmark changes.
Earnings upgrade; reduced capex and some disposal cash flows. Both Public Transport Operators (PTOs) should benefit from the transition to a more sustainable model, as this should ward off operating difficulties for them. CD, through SNS Transit, operates about 75% of Singapore’s 4,500 public buses, while SMRT runs the remaining 25%. CD’s Singapore bus business (19% of revenue) made a small operating profit of S$3.2m (only 1.8% EBIT margin and 3% of group EBIT) in 1Q14, while SMRT Buses (also 19% of revenue) incurred an operating loss of S$28.4m in FY14. CD’s bus assets on its books are valued at c.S$820m and SMRT’s, at S$250m. While EBIT margins for both may not spike immediately, both certainly have advantages over any new competitor, given their extensive knowhow and track record in running public buses in Singapore.
What You Should Do
Sector upgraded to Overweight. We keep our Add rating for CD with a higher DCF-based target price (WACC 7.1%) after upgrading our earnings. It should be a clear beneficiary of the most significant development in the local bus industry in recent times. We upgrade SMRT to Add from Hold, given its greater earnings sensitivity to this move (see separate notes on CD and SMRT).
Land Transport – CIMB
Cool winds of change
With changes to the public bus system just announced by the government, both CD and SMRT can expect to eliminate operating losses in this segment of their business and improve their cash flow through lower capex and asset disposals. Conventional thinking favours CD (Add, target S$2.59) as the biggest winner, owing to its larger bus fleet and experience with cost-plus models, but we think that SMRT’s (upgraded to Add, target S$1.67) performance will also improve, as this development could serve as a prelude to a new rail financing framework. We upgrade the sector to Overweight from Underweight, with catalysts from more government initiatives and SMRT as our top pick.
What Happened
The government is revamping Singapore’s public bus industry to a “government contracting model”, starting 2H14. Under the new system, the government will own all bus infrastructure (depots, buses and systems).
Implementation only in 2H16. Initially, LTA will tender out three packages of bus services (out of a total of 12), starting with the first package in 2H14, for implementation in 2H16. The three packages will cover 20% of the existing buses. LTA will negotiate with the incumbents to run the remaining nine packages (80% of existing buses) under the contracting scheme, for durations of about five years when their Bus Service Operating Licences (BSOLs) expire on 31 Aug 16. After their expiry, more bus services will gradually be tendered out. The contracts will be valid for 5+2 years.
What We Think
The devil is in the detail. Details of the first bus package will be out next week. After 2022, all packages will be tendered out, with the aim of having at least 3-5 bus operators in the market. While some numbers regarding margins, the transfer of assets to the government and contracting are not out yet, we have made certain assumptions for CD and SMRT, to estimate the impact on their earnings, balance sheets and fleet-disposal plans to reflect these landmark changes.
Earnings upgrade; reduced capex and some disposal cash flows. Both Public Transport Operators (PTOs) should benefit from the transition to a more sustainable model, as this should ward off operating difficulties for them. CD, through SNS Transit, operates about 75% of Singapore’s 4,500 public buses, while SMRT runs the remaining 25%. CD’s Singapore bus business (19% of revenue) made a small operating profit of S$3.2m (only 1.8% EBIT margin and 3% of group EBIT) in 1Q14, while SMRT Buses (also 19% of revenue) incurred an operating loss of S$28.4m in FY14. CD’s bus assets on its books are valued at c.S$820m and SMRT’s, at S$250m. While EBIT margins for both may not spike immediately, both certainly have advantages over any new competitor, given their extensive knowhow and track record in running public buses in Singapore.
What You Should Do
Sector upgraded to Overweight. We keep our Add rating for CD with a higher DCF-based target price (WACC 7.1%) after upgrading our earnings. It should be a clear beneficiary of the most significant development in the local bus industry in recent times. We upgrade SMRT to Add from Hold, given its greater earnings sensitivity to this move (see separate notes on CD and SMRT).
SMRT – CIMB
Out of the dark tunnel
We raise SMRT’s FY17 EPS by 13% to incorporate its higher earnings sensitivity to the new government contracting model for buses, which lifts our DCF-based target price (WACC 7%). Other potential re-rating catalysts are better earnings from cost-control measures. We also suspect that this new bus model is a prelude to a rail financing model. Given further positive news flow expected, we upgrade the stock from Hold to Add.
What Happened
The government is revamping Singapore’s public bus industry to a “government contracting model”, starting 2H14. Under the new system, the government will own all bus infrastructure (depots, buses and systems). Implementation starts only in 2H16 (details overleaf).
What We Think
Better earnings, also cash flow and balance sheet. More details will be unveiled next week with the announcement of the first bus package. SMRT’s Singapore bus business in FY14 contributed S$217.8m in revenue (19% of total revenue) but lost S$28.4m at the operating level. If its operating margins eventually mirror those of bus operators in Australia and the UK, at 10-17%, SMRT’s bus EBIT margin as a whole can shift up to a conservative 7% in FY17 and 12% by FY18, in our estimation, from current negative territory. We are assuming reduced capex spending of 20% for FY16 and 47% for FY17 and asset disposals of c.S$25m in FY17. Net gearing should fall to 27% by then. FY17 EPS could be lifted by 13%, simply from larger revenue contributions and the elimination of bus operating losses.
What You Should Do
Upgrade to Add. Contrary to conventional thinking, we think that the bigger beneficiary should be SMRT, as it is the one with greater earnings sensitivity to the changes. Added to this is a new rail financing framework under discussion, with the earlier-than-expected move on the bus model serving as a prelude to the rail model. All these change our mind on the stock and we upgrade it to Add.
SATS – CIMB
Expensive caterers
We downgrade SATS to Reduce from Hold with a lower target price of S$2.95, still based on 16x CY15 P/E (5-year mean). Without a major breakthrough in transforming the group, we think that its near-term operations could remain challenging as both topline and margins could be under pressure. FY14 net profit missed our forecast by 11% and consensus by 6% due to weakness in food solutions (weak TFK and lesser meals served). Associates/JVs were also affected by high costs in Hong Kong and weak cargo volume. We cut our FY15-16 EPS by 12-14% and introduce FY17 forecasts. The longer-term outlook (beyond FY17) could be positive, driven by tourism in Singapore and growth in Changi Airport, but valuations (above 5-year mean) look stretched for now.
Weak topline
FY14 revenue slipped by 2% yoy to S$1.787bn, largely on a 5% drop in food solutions (62% of revenue). The key culprits were 1) an 18% drop in contribution from TFK (in line with the c.14% depreciation of ¥ vs. S$), and 2) lower meals produced (-6% yoy to 20.6m units) from the loss of Emirates’s European flights. This is mitigated by higher gateway services (+4.5% yoy) with more passengers and flights handled in Changi Airport. We now expect a 4% yoy rise in revenue in FY15, assuming TFK’s revenue has bottomed and the effects from Emirates’s flights will diminish. Note that TFK was profitable in FY14.
Can’t fight the high staff costs
Food solutions’s operating margin dropped to 12.9% from 13.6% in FY13 and that of gateway services shrank to 2% from 3% in FY13, driven by high staff costs. Overall staff costs rose 3% yoy to S$788m or 44% of total expenses. This pressure is likely to stay given its labour-intensive business model. Benefits from automation may work in its favour over the longer term but it takes time for these incentives to materialise.
Long-term story
SATS declared a final dividend of S$0.08 (total: S$0.13), lower than our expectation of S$0.15. Net cash stood strong at S$228m. SATS is a long-term stock to own but not now, as cost headwinds persist.