Cost controls in place but little else

• In line. M1’s 1H09 annualised results are in line with market and our expectations, with deviations of 0.3% and 0.7% respectively. As expected, a tax-exempt interim DPS of 6.2cts (2Q08: 6.2cts) for a 70% net payout was declared.

• Topline belatedly rose. M1 reversed four successive quarters of revenue decline with revenue growth of 2.2% this quarter, thanks to higher postpaid revenue, more emphasis on customer acquisition/retention, higher handset sales, stabilising roaming and robust growth of wireless broadband. Postpaid revenue (65% of 1H09 revenue) rose 1.1% qoq, aided by a 0.8% qoq increase in postpaid subscribers and a 1.1% increase in ARPUs largely due to the success of its Take 3 programme. Take 3 has also attracted more mid-to-high-end users.

• Cost controls hemmed in higher SARC. Despite chasing market share and ramping up subscriber acquisition and retention costs (SARC), EBITDA margins were fairly stable qoq (+0.1% pt qoq), thanks to fairly active cost control. The main savings came from lower staff costs from a freezing of headcount, and lower bonuses and bad debts.

• Guidance in place. M1 elucidated its 1Q guidance of “stable operations”. It now expects FY09 PAT to be comparable to FY08’s, in line with our forecast of 1.8% yoy growth, despite challenging operating conditions. It will continue to focus on cost management, efficiency, the introduction of new initiatives to address growth segments and investing in future growth. M1 also reiterated its dividend policy of an 80% net payout for FY09.

• Maintain forecasts, target price and rating. We leave our forecasts and DCFbased target price of S$1.54 (WACC: 11.5%, LT growth: 1%) intact as the financial performance was in line. M1 remains a NEUTRAL as we see few positive catalysts for the stock. While revenue has rebounded qoq, growth remains unexciting. But downside should be limited by its attractive yields of about 9%. Our top pick remains SingTel (OUTPERFORM, target of S$3.20 under review). For exposure to yields, we advocate a switch out of StarHub (Underperform, target S$1.58) to M1.

2Q FY2009 results

2Q FY2009 results. For 2Q FY2009, M1 reported operating revenue of S$190.5m (-7.2% yoy), profit before tax of S$45.0m (-11.4% yoy) and net profit of S$37.1m (-9.7% yoy).

There are four main revenue segments: telecommunication services, international call services, fixed network services and handset sales. Telecommunication services registered 7.7% decrease in revenue to S$141.6m. Postpaid revenue fell by 8.5% to S$124.0m while prepaid revenue decreased by 2.2% to S$17.5m. Moreover, international call services posted 13.7% drop to S$32.8m while handset sales rose by 12.2% to S$15.6m. Fixed network services was a new segment that contributed revenue of S$0.5m.

Operating expenses also decreased to S$144.1m (-5.6% yoy) due to lower staff costs, facilities expenses amd provisions for doubtful debts. M1 benefitted from the Jobs Credit Scheme, paid lower bonus and hired fewer staff.

Therefore, net profit decreased due mainly to lower revenue despite lower operating expenses.

Profit margin. Net profit margin decreased from 22.5% in 1Q FY2009 to 19.5% in 2Q FY2009 due mainly to higher operating expenses. Based on a year-on-year comparison, it fell from 20.0% in 2Q FY2008 due to lower revenue.

Increase in number of customers. M1 saw an increase in the number of prepaid and postpaid customers from 740,000 and 879,000 in 1Q FY2009 to 783,000 and 886,000 in 2Q FY2009 respectively. Its market share for the prepaid and postpaid segments has changed from 23.9% and 26.8% in 1Q FY2009 to 24.5% and 26.5% in 2Q FY2009 respectively. We are concerned as M1 continues to lose market share for the postpaid segment. This is because M1 does not have Pay TV and is unable to offer bundled services to customers.

Outlook for FY2009. M1 expects 2009 to be a challenging year due to the global financial crisis. However, it expects the net profit for 2009 to be comparable to 2008. Moreover, its dividend policy for 2009 is to pay 80% of net profit after tax as dividend. Maintain Hold with fair value at S$1.67. We keep our hold recommendation on the stock because M1 has a limited focus on the domestic market and does not have Pay TV services. As M1’s net profit of S$37.1m only came in 3.6% below our expectation of S$38.5m, we maintain the target price at S$1.67 based on our valuation using the free cash flow to firm model.

Improved execution

• Net profit exceeded our expectations as M1 arrested market share decline, without hurting the margins.
• Added 50K new subscribers in the quarter, compared to a loss of 12K in 1Q09
• Announced interim dividend of 6.2 cents per share. Reiterate BUY for 12% potential share price upside, 9% regular yield and an additional 10-20% yield through potential capital management in FY10F.

In 1H09, M1 has achieved 51% of our FY09F forecast. Core net profit of S$37m (+5% y-o-y excluding S$6m one-off gain last year, +3% q-o-q) exceeded our S$33m forecast, due to lower staff costs, network related expenses and lower than expected increase in marketing expenses. We like to highlight that M1 has negotiated lower network expenses for FY09F, which alone should result into annual cost savings of about S$10m. Management declared interim dividend of 6.2 cents, flat yoy, in line with our expectations.

Operating metrics look better. Most importantly, mobile market share decline was arrested. It stood at 25.5% compared to 25.4% in 1Q09. ARPU was stable as minutes of usage showed some improvement sequentially. Churn rate of 1.5% was slightly lower than 1.5% in 1Q09.

M1 may not remain undervalued with signs of improved execution. Next year, M1 would benefit from about S$10-15m cost savings from the shifting of traffic to M1’s own backhaul network, implying room for earnings growth. Management is also enthusiastic about benefits from National Broadband Network in 2010. Maintain Buy with target price of S$1.80, pegged at 11x PER, a 10% discount to our StarHub’s target PER of 12x.

Earnings and fair value revised up

• Results were marginally better than expected, despite the headline fall in topline and bottomline numbers for 2Q09 on a YoY basis. 1Q09 marked a low point, with encouraging signs of improving quarters. We are revising EPS up by 3% for FY09 and FY10. Our fair value is also revised upwards by 12% to S$2.03/share.

• Total revenue fell 7% YoY to S$191mil in 2Q09, but this was a 2% pick up from its low point in 1Q09. Its mobile subscriber base turned around from a contraction in 1Q09 to register net adds of 9,000/month in 2Q09.

• However, this came at the expense of higher subscriber acquisition cost (SAC) and retention cost. SAC picked up from S$134/subscriber in 1Q to S$151/subscriber, while retention cost rose from S$116/subscriber to S$150/subscriber. Total subscribers grew 4% YoY to 1.7 million with prepaid mix improving to 46.9%.

• Postpaid ARPU picked up from its low point in 1Q09 to S$60.70/subscriber in 2Q09, while prepaid continued its decline to S$15.50/subscriber. With the launch of several higher value data plans, the fall in data plan ARPU was stemmed in 2Q09, showing a slight improvement at S$22.80/subscriber.

• Contribution from non-voice services was maintained at 25.1% of service revenues, but it would be more important to note that mobile data contribution continued to rise to 10.9%.

• Going forward, M1 has a few initiatives up its sleeve, which targets the high value segment. Its first such initiative was launched in 1Q09. Take 3 is gaining traction with about 20% of new subscribers taking up this plan. Take 3 offers a selection of data-centric handsets bundled with higher value plans, without requiring customers to purchase the handsets.

• On the back of better economic outlook with the recent spate of GDP upgrades, we have also
upgraded our topline inputs with subscriber growth of 4% to 6% till FY11. With M1’s tight cost management, we expect EBITDA margins to maintain at a high 45%.

• M1’s rollout of its backhaul network will be completed at end of 2009 and the cost savings will help to mitigate increased capacity requirements for higher data usage.

• Management is maintaining its policy to payout 80% of net profits in dividends. This puts yield at over 8% per annum. A 6.2 cent Singapore DPS was declared for 1H 2009.

• We maintain a BUY rating on M1, which offers a 20% upside to its fair value of S$2.03/share. M1 is gearing up to participate as a Retail Service Provider in Singapore’s Next Generation National Broadband Network project, which is scheduled to come onstream in April 2010. This opens up a new revenue stream as well as potential for cross service bundling opportunities.