Lower-than-expected capital management

• In line. At 3% below our forecast and 1% below consensus, FY10 net profit was in line with expectations. M1 declared a final DPS of 7.7 cts and a special DPS of 3.5cts, bringing FY10 DPS to 17.5 cts for a 100% payout. Nevertheless, the special DPS fell short of our 10ct/share projection. We cut our FY11-12 earnings by 1-2% for housekeeping purposes and introduce FY13 forecasts. While we make no changes to our DCF-based target price of S$2.65 (WACC: 8.5%), we downgrade the stock from OUTPERFORM to NEUTRAL as M1 has outpaced the market by 6% since we upgraded it last July and because of the lower-than-expected capital management in 4Q10.

• Strong topline but weak margins. Topline rose 6% qoq in 4Q10, led by higher handset sales (+17% qoq) as smartphones remained popular, principally iPhones. The topline was also boosted by postpaid revenue (+3% qoq) as postpaid net adds touched 25K, the highest since our records began in 2004. Meanwhile, margins in 4Q10 dipped 3.1% pts qoq due to higher handset costs as more handsets were sold, staff costs due to the payment of bonuses and performance incentives and higher marketing expenses.

• Capital management fell short of our expectations, though that was better than nothing. M1 was vague about the frequency of capital management going forward although it would review this from time to time. It frames its dividend policy on the long-term sustainability of its payouts and considers its current policy as fairly aggressive. We believe M1 is being slightly conservative as its net debt/EBITDA of 1.0x at end-4Q10 was healthy, its working capital stable and its capex manageable.

• Guidance for 2011. M1 expects full-year profit growth and capex of S$100m in addition to sustaining its 80% payout. Growth in 2011 would come from mobile data given low penetration rates and the increasing number of devices carried around by individuals, its fixed service offerings and penetration of the underserved SME market. It would also focus on new initiatives such as near field communications and location-based applications.

Here Comes The Money

M1’s FY10 results were in line with our/consensus expectations. A key sweetener was the earlier than expected special dividend proposed of 3.5cents/share, when combined with the final and interim payouts bumped up FY10 DPS to 17.5 cents/share or a compelling 7% yield. Following the results, we nudge our FY11/12 forecast higher by 3-8% to reflect the improved revenue traction, stronger data uplift and some revenue contribution from the NGNBN. While the stock has enjoyed a good run over the past month, our revised TP of SGD2.85 offers a further 14% upside potential. M1 remains our top pick for exposure to Singapore telecoms. BUY.

Bang in line–special dividend of 3.5cents/share. M1’s 4Q10 net profit was up 0.8% y-o-y (-5.1% q-o-q), driving FY10 net profit to SGD157.1m (+4.5% y-o-y). This compares with our forecast of SGD158.1m and consensus estimate of SGD158.4m. In meeting its 80% dividend payout guidance, a final dividend of 7.7cents/share was proposed. The pleasant surprise however came from an earlier than expected special DPS of 3.5cents/share, bringing FY10 cumulative DPS to 17.5cent/share, or a net payout of 100% (the last time M1 dished a special dividend was in FY07). Key takeaways for the quarter include: (i) the stronger 2.7% q-o-q (+3.7% y-o-y) uplift in service revenue following 3 quarters of flat showing as IDD revenue recovered, up 3.4%- the strongest q-o-q growth since 2QFY08 and brisk smartphone sales (55% of its subs base on smartphones); (ii) 2%-pts erosion in EBITDA due to the typically higher acquisition activities during the year end and the launch of its NGNBN services last September. Non voice revenue expanded to 33.3% in 4QFY10.

Mal-Sing roaming rates still fluid. M1’s revelation that it is still awaiting further directives from the IDA on the potential cut in the roaming rates for Malaysia and Singapore is consistent with our expectation in that there could be further delays in the implementation. Management indicated that 12-15% of its service revenues are from roaming (a sizeable portion from Malaysia) and where it is a net-outpayer of roaming.

100% payout likely to continue

At a Glance

• 4Q10 net profit was broadly inline with expectations.

• Including special DPS of 3.5 Scts, full year DPS of 17.5 Scts represents 100% earnings payout ratio.

• Management guided for improved net profit in 2011, as per expectations.

• Maintain BUY at over 7% yield assuming 100% payout.

4Q10 net profit of S$37.5m (+1% yoy, -5% qoq) was inline. Full year net profit of S$157.1m was up 4.5% yoy on the back of lower leased circuit costs, which declined 20% yoy to S$44.1m as M1 started to use more of its own backhaul network.

Mobile market share was stable while churn rate declined further. Mobile market share was stable sequentially at 26.3%. M1 made gains in the post-paid while lost in the pre-paid segment. Churn rate declined to 1.3% in 4Q10 from 1.4% in 3Q10. (1.6% in 4Q10 each), lowest ever since introduction of mobile number portability in 2008.

100% earnings payout likely in FY11F in our view. While official earnings payout guidance remains at 80%, we think there is a strong likelihood of 100% payout in FY11F, given that: (i) M1 has guided for a flat yoy FY11F capex of S$100m; and (ii) working capital changes should be neutral or positive compared to S$84m in FY10 due to fair value accounting. A free cash flow yield of 8%-10% could easily support a 7% dividend yield.

Management guidance of “growth in net profit” in FY11F. M1 attributes this to: (i) higher broadband contribution from both SME and residential segments; (ii) more effective bundling of its pay TV (web TV), broadband and mobile services. We have slightly trimmed our FY11F earnings a to account for possibly lower roaming fee.

M1 Q4 earnings inch up to $37.5m

Full-year dividend payout of 17.5cents is highest since 2006

M1’s fourth-quarter profit inched up 0.7 per cent to $37.5 million, from $37.2 million a year earlier as higher handset subsidies continued to erode its bottom line. However, shareholders should have no reason to complain as M1 is rewarding them with its highest dividend windfall since 2006 on the back of sustained profitability.

Earnings per share at Singapore’s smallest mobile phone operator stayed flat at 4.2 cents for the three months ended Dec 31, 2010. Revenue climbed 20.9 per cent to $261.4 million for the period.

For its full 2010 financial year, net profit rose 4.5 per cent to $157.1 million, while sales grew 25.3 per cent to $979.2 million.

The company has proposed a final dividend of 7.7 cents per share and a special dividend of 3.5 cents per share.

This takes M1’s full-year payout to 17.5 cents, or 100 per cent of net profit, its highest in the last four years.

‘We have been very disciplined in our deployment of cash and built up a very strong track record of capital distribution to shareholders,’ said M1 CEO Karen Kooi.

‘With our proposed final and special dividend, our total dividend yield for 2010 will be about 7 per cent,’ she said at the group’s results briefing yesterday.

In 2010, M1’s bottom line was up slightly as operating expenses climbed 30.5 per cent year on year to $785.2 million. Soaring handset subsidies were the main culprit as they caused M1’s cost of sales to spike 50.6 per cent to $492.2 million.

Last year, all three local telcos were plagued by the same issue of rising costs as Singaporeans continue to snap up feature-rich handsets such as the iPhone. Operators typically offer heavier upfront subsidies for these phones and try to recoup the investment over the subscriber’s contract.

At M1, more than 90 per cent of the handsets that it sells are smart phones and some 55 per cent of its post-paid subscriber base is using these devices, said Ms Kooi.

In 2010, M1 added 89,000 new post-paid mobile subscribers, compared with 30,000 in the preceding year, to take its total handset user base to 1.91 million.

For the current year, the firm plans to ramp up its fibre-optic service offerings as Singapore’s Next Generation Nationwide Broadband Network continues to gather steam.

The company will also upgrade its cellular infrastructure by investing in a technology called LTE to allow for higher mobile data speeds.

‘Based on the current outlook and barring any unforeseen circumstances, we are likely to see improved net profit after tax for the year 2011,’ Ms Kooi said, adding that the firm’s dividend policy would remain at 80 per cent of post-tax profits.

M1 shares closed one cent higher at $2.50 yesterday before its Q4 and full-year earnings were released.

Nice way to start the new year

Event

• M1 will report its full‐year FY10 results next Wednesday. While we expect the results to be good but not extraordinary, its share price has risen 12% since early last month on dividend expectations and perhaps, market speculation that it may be the next takeover target, as Axiata owns close to 30% stake. But we do not think the Malaysian mobile operator will want to buy the rest of M1 or to sell its stake. Nevertheless, as our target price has been increased to $2.88 (16% upside) upon rolling over to FY11 forecast, we maintain our BUY call.

Our View

• M1 will report FY10 results next Wednesday after the market closes. We expect revenue to grow 10.5% YoY to $239m and earnings to rise 4% YoY but fall 1.5% QoQ on higher year‐end A&P expenses and smartphone subsidies. Also, the final dividend per share of $0.078 is expected to exceed FY09’s $0.072 for a total full‐year DPS of $0.142.

• In the light of recent M&A events, M1 stands out for its significant Malaysian interest. Mobile operator Axiata owns a 29.5% stake, or 265.4m shares, of which 118.5m shares were acquired from former shareholders C&W and PCCW at $2.20 a share and the rest at $1.85‐2.05 between August 2005 and March 2006. Add $0.55 in dividends paid since FY06, Axiata’s average cost could be as low as $1.50.

• However, we think it is unlikely that Axiata would want to take over M1 or to sell its stake. It has been scaling back capex in recent years and has just reduced its net debt/EBITDA to below 1x. Our Axiata analyst also believes buying M1 would eat into its funding for other more important investments. On the flip side, it would be difficult for Axiata to find another investment that can yield more than 10% annually. However, a potential buyer may have to pay as high as $3.54, going by our DCF valuation.

Action & Recommendation

We maintain our BUY call and raise our target price to $2.88 (from $2.63) as we roll over to FY11 valuation target of 15x PER and 5% dividend yield.