Cracks surfacing at the telco fort?

Japan’s disaster is shaking even stocks that used to help shelter investors from market turbulence

AN ebbing tide lowers all boats and this time around, even telecommunications counters that have helped shelter investors from past market turbulence appear to be reeling from aftershocks of the devastating earthquake which hit Japan last week.

Singapore Telecommunications, which is traditionally seen as a defensive play, also fell victim to the global market sell-down this week with its shares tumbling to a nine-month low of $2.85 yesterday.

‘Surprisingly, a number of incumbent telcos have been weak across the region despite the broader market volatility,’ said Sachin Gupta, a senior analyst at Nomura Securities.

Investors appear to be spooked by SingTel’s overseas exposure as global economies continue to be rocked by the uncertain fallout from Japan’s worst natural disaster in nearly 100 years.

The Republic’s largest operator derives 74 per cent of its Ebitda (earnings before interest, tax, depreciation and amortisation) from its Australian subsidiary Optus and its six mobile associates across the region.

‘SingTel is facing some uncertainties, especially on regulations in India and rising competition in the Australian market,’ Mr Gupta explained.

‘The sheer exposure of the group (SingTel) to overseas markets makes the stock susceptible to external volatility,’ said OSK Research’s telecommunications analyst Jeffrey Tan, adding that investors could also be worried about a potential loss in roaming revenue as traveller numbers start to dwindle.

‘SingTel has the largest pool of foreign shareholders and investors so it would be reasonable to expect the stock to suffer a bigger sell-down on the back of prevailing concerns in the region,’ he told BT.

Selling pressure also gripped SingTel’s US counterparts including AT&T, Verizon and Sprint Nextel this week. In the region, shares of Australian telco Telstra fell 0.38 per cent to close at A$2.64 yesterday.

The exception to the rule appears to be telcos with high and sustainable dividend yields, Nomura’s Mr Gupta noted.

Singapore’s smallest operator M1 is one such counter that is favoured by most market watchers. The company’s proposed cash payout of 17.5 cents per share for 2010 translates to a sizeable yield of 7 per cent.

M1 shares held steady for most of this week but edged down one cent to $2.38 yesterday. Both Nomura and OSK have a ‘buy’ rating on this counter.

StarHub received mixed ratings from analysts, with Nomura giving it ‘reduce’ call while OSK rates it as ‘neutral’. StarHub shares closed unchanged at $2.61 yesterday.

While Singapore’s second-largest operator is viewed to have a lower ceiling for growth compared to M1 this year, StarHub’s domestic focus and dividend yield should help limit its share price downside, analysts say.

Meanwhile, OCBC Research has a ‘buy’ call on all three local operators.

‘While we continue to like the telcos for their yields and defensive earnings, we do not see any big growth drivers for them this year and hence our sector call is neutral,’ said OCBC research analyst Carey Wong.

Clearer skies for mobile sector

THE smartphone bug that took a bite at all three telcos’ earnings in the past year is finally expected to loosen its grip in the coming months. While this will bring some much-needed reprieve for their core mobile businesses, the onset of higher pay-TV content costs and possible broadband price erosion may mean the bottom lines from their local operations could be little changed at the end of 2011.

In the past 12 months, the once-scarce iPhone became an accessory of the masses as Apple ditched its one-operator strategy in favour of broader distribution.

This triggered a mad smartphone rush among local consumers as both Apple and non-Apple touch-screen handsets flew off the shelves, ending up in the hands of teenagers and grandparents alike.

However, the aggressive subsidies that came with these phones meant all three operators had to bear with some short-term pain initially before they could reap any long-term gain.

Handset costs rose to 33 per cent of sales at M1, while SingTel and SingTel also experienced steep hikes over the course of 2010.

The good news for the trio is that the end appears to be in sight and margins should start to improve from now on.

In fact, StarHub is already showing early signs of turning the corner in the fourth quarter of 2010. Profit from its operations grew 12 per cent in Q4 to $99.7 million from a year ago, while cost of sales fell 9 per cent to $210 million.

Smartphone penetration among postpaid subscribers now stands at around 60 per cent across SingTel, StarHub and M1. Most handset users made the transition in 2010 and are now locked into two-year contracts.

Moreover, smartphone adoption is not likely to shoot past the 80 per cent mark as there is still a large pool of users, such as the elderly, who are resistant to the switch.

As the handset fever subsides, and the bane of higher subsidies eases, telcos can finally sit back and start to reap the fruits of their labour. Telcos have previously stated that they would require three to six months to recoup the subsidy for a smartphone user and this should happen in 2011.

In addition, the coming tablet glut, including the much-hyped iPad 2, could give their mobile subscriptions a further boost.

This is because 3G-enabled touch-screen slates can boost cellular revenue without the bane of incurring an upfront loss. All three telcos have already introduced iPad-specific data plans and more competitive packages could be launched in response to the tablet onslaught in the coming months.

A few things could, however, tilt the balance. In particular, the launch of another market-moving device such as the iPhone 5 could spark mass upgrades and drag the telcos back to square one.

However, the timeline for its launch remains unclear. Even if the fifth-generation Apple phone is released within the next few months, it should only reach local shores in the third or fourth quarter, and consequently, the pinch should only be felt in 2012.

While mobile margins are set to improve, the impact could be negated by higher content acquisition costs. This is particularly true for SingTel and M1.

Having established a beachhead among local sports fans with the Barclays Premier League, SingTel has laid down the gauntlet by declaring its intention to conquer more subscriber segments. This would involve the acquisition of new programme genres.

The same is true for M1 if it wants to improve on its nascent ‘1box’ pay-television offering. Despite the introduction of the government’s cross-carriage pay-TV policy this year, it is unlikely that content owners would drastically reduce the premiums they place on their offerings.

On the broadband front, the much-prophesied competition that will arise from the dawn of fibre-optics in Singapore will not materialise this year.

Several hiccups now stand in the way of broader adoption. On the one hand, a large number of condominium residents are still cut off from ultra high-speed broadband due to disagreements over cabling procedures. On the other, operators such as SingTel and StarHub have little incentive to push for fibre-optic adoption for the time being as it could cannibalise their existing broadband revenue streams.

The rivalry may intensify towards the end of this year when the new network nears completion but status quo should be maintained in the interim.

In recessionary times, the stable nature of telecommunications operators is a much sought-after virtue but this becomes less attractive when an economic boom is at hand. This can be seen by recent ‘underweight’ calls that have recently been placed on the telco industry.

However, the sector’s high-dividend yield, coupled with its defensive nature, means it should still be worthwhile consideration in any smart investor’s portfolio.