1Q09 result preview – eyes on the top lines

• 1Q09 results preview: eyes on the top lines: SPH will announce its 1Q09 result on 12 Jan 09; our revised estimates for 1Q09 will be about S$100MM, subject to some swings from property development profit and investment income. Key things that we will watch for in the results include: 1) a potentially higher-than-expected newsprint charge-out price given SPH locked in the cost 6 months back during the peak, and 2) the magnitude of decline in revenue from core business, although we believe that 1Q09 revenue for the core business could be the highest of the year.

• Operating leverage could magnify the decline in revenue: We estimate that more than 75% of SPH’s cost base is fixed, putting the group at a disadvantage given the operating leverage. We estimate that for every 10% drop in newspaper and magazine revenue, the group’s earnings from core publishing business would decline by about 19%. The lagging growth trend in newsprint price (by about 2 quarters) could also worsen the operating conditions for SPH, in 1H09 in particular.

• Revising our earnings estimates downward: We revise our earnings estimates down by 9% and 11% for FY09E and FY10E on the back of lower revenue from newspaper and magazine. We also revise our dividend forecast down to S$0.22/share for both FY09E and FY10E from S$0.27/sh in 2008. Historically, amidst the recession in 2001 SPH has cut its special dividend payout, and we believe a cut this year is possible.

• We reduce our Dec-09 price target to S$3.90, based on our SOTP valuation, and we maintain our OW rating. Key risks to our rating and price target include 1) lower than expected revenue from the core business, 2) lower than expected income from investment, and 3) a sudden drop in rental rate for Paragon.

Yields still attractive

• We believe that SPH’s core media earnings are less at risk from the recession than many Asian media stocks, since SPH controls more than 90% of newspaper advertising in Singapore. This mitigates the worst effects of competition in a recession. While industry adex is likely to contract, SPH’s newspaper advertising should benefit from trading down from television advertising. Classified revenue had fallen 6% yoy in the last results, but this was muted compared with most other companies. Retreating commodity prices are also positive for SPH, as newsprint costs are unlikely to rise further.

• Property recognition to shore up earnings; risks not overwhelming. Media earnings contraction is likely to be cushioned by profit recognition for the Sky@eleven residential development project, and Paragon. For Sky@eleven, buyers’ default risk is fairly low, in our opinion, even though SPH has allowed the Deferred Payment Scheme to be transferred to second buyers. For default risks to become real, selling prices would have to fall by more than 20% below the project’s launch price of S$975psf. For Paragon, we are already valuing this property at S$1.5bn, vs. SPH’s latest revaluation of S$2.0bn, in mid-2008.

• Forecasts reduced; sum-of-the-parts target price trimmed to S$4.01 from S$4.50. In view of the weak economic environment, we expect print ad revenue and investment income to decline. We have cut our earnings estimates by 12-14%. Nevertheless, maintain Outperform. We expect SPH to pay S$0.26-0.27/share in FY09-10, with yields of more than 8%.

Unprecedented Value

Core media business below historical low
We are revising our ad revenue growth assumption to -20.0% from 3.0% given the negative GDP outlook. Historically, ad revenue growth underperforms GDP growth in a market down cycle. In 2002, ad revenue declined 19.8% yoy. Overall revenue is estimated to fall by 1.6% in FY09F, mitigated by the contribution from Sky@Eleven. At 11.8x forward PER, SPH is now trading at its trough valuation. Our implied valuation of the core media business shows a trading PER of 10.6x, which is below the previous low of 11.8x over the last 10 years of trading.

Cutting cost to counter recession
We have reduced our FY09F staff cost estimates by 29% following the cost cutting instituted by the management, with employees’ variable wage component at about 10%. FY09F net profit estimate is reduced to $424.3m, representing a 2.8% decline yoy. The impact of changes to estimates are a lower DPS of 23.8 cts for FY09F and 22.2 cts for FY10F, translating to a yield of 7.6% and 7.1%, respectively. The estimates are based on 90% payout from both media and development income.

Free cash flow to support payout
We expect free cash flow of $408m in FY09F and this should support the dividend payout of $380m. SPH is in a net cash position of $280m as at Aug’08, with $1.1b in investible funds. An additional $150m three-year loan inked recently may be deployed for overseas media joint ventures.

Dividend track record a key attribute
SPH remains one of our most defensive pick, as the company rewards shareholders with dividends even in bad times. Assuming 90% payout of recurring earnings, we are projecting a normalized yield of 5.2% (excluding payout from Sky@Eleven), which depicts more sustainable dividend profile as contribution from property development will cease from FY11.

Lower core media business valuation impacts SOTP target price
Our new SOTP target price of $4.48 is derived from the lower DCF valuation of the core media business of $2.96 (7.4% WACC and 2% terminal growth rate) and further assuming a 10% mark down on investments given the uncertain equity market. Our valuation assumption of $2b for Paragon remains intact as we believe that the opening of competing up-market shopping malls along Orchard Road in 2009 may raise the profile of surrounding properties and lend support to valuation. There is a 43% price upside to the new target price. Maintain Buy.

Outperforms STI by 23%

Resilient in carnage. Singapore Press Holdings (SPH) has weathered the current financial storm in a better fashion than most of its STI peers. While the STI plunged 36.4% in Oct-Nov, SPH demonstrated resilience by falling only 13.5%, thus outperforming the STI by a credible 22.9%.

Growth looking more elusive. With Singapore falling into the deeper recesses of economic difficulties, we are expecting SPH to suffer in tandem as advert and classified revenues fall while costs edge upwards as it has to push through its new media development strategy. As a recap, SPH delivered 12.3% YoY topline growth to S$1.316b but PATMI still fell 12.4% YoY to S$437.4m. The topline was helped by a stronger recognition of the Sky@Eleven project while the poorer bottomline was due to less investment income and impairment charges.

Lowering expectations. In view of the challenging year ahead, we have lowered our estimates for its core printing business by 4%. While we understand that Paragon is a jewel in Orchard Road, we still lower our upward rental revisions for renewals to a similar level to FY08 to cater to the mounting difficulties faced by luxury goods retailers. We also anticipate a 10% cut in valuation for Paragon in its next exercise in Jun 09. The only foreseeable upside is SPH’s higher ecognition from its Sky@Eleven project for FY09.

Cash preservation mode. We specifically mentioned in our 13 Oct 08 report that while SPH has stepped up its dividend/share to S$0.27 for FY08, we feel that management sent a clear signal when it iterated that it does not have a dividend policy. With our latest earnings revisions, our last estimate of S$0.24/share is further cut to S$0.215/share. Our reason for the dividend cut is not based on the buyer default rates of the Sky@Eleven project but more a function of free cash flow. While SPH continues to recognize revenue via progressive construction stages, there is marginal real cash flow into the company. We expect TOP in 3Q2010 which implies that buyers have till then to obtain appropriate financing. Despite the cut, FY09 still gives a dividend yield of 6.1%.

Maintain BUY but lower valuation. While we have reduced our fair value to S$4.86 (prev. S$5.14) based on our SOTP valuation, we expect SPH to continue its outperformance in this down market. Maintain BUY.

Pressure on SPH’s earnings, but valuations should pull through

• Could there be repercussions from not reigning in DPS? We examine the risk of default at the Sky@Eleven property project given that recent sub-sale transactions have started to fall below the original average selling price of S$975psf. Most of the unit sales have been on a Deferred Payment Scheme (DPS) basis and from what we understand, none have been converted to progress payments, hence financing could become difficult later if asset prices fall at an unprecedented rate.

• Defaults would hit FY10E earnings but not SOP: If defaults arise when the Temporary Occupation Permit (TOP) is issued in 2010, we do see a significant hit to our FY10 estimates as SPH will have to write back earnings recognized before that point. However, we do not expect a significant impact to our Jun-09 SOP-based S$4.65 PT as the NPV of the project currently accounts for only 7% of our SOP. The bulk of value in SPH is still the publishing business at 60% of the SOP based on a historically resilient 12x trailing P/E. The Paragon mall supports 28% of SOP. Risk to our PT is a perceived de-rating in the publishing business in the form of lower circulation rates; SPH has differentiated itself from Western media which has succumbed to growth of the internet platform.

• The biggest hit from Sky@Eleven defaults would be on dividends: If anagement decides not to pay out the related property development earnings on perceived risk of defaults, dividends could be cut by as much as 10 cents per share, or 36%, in FY09 and FY10. A lower dividend yield could affect the stock’s ongoing outperformance. However, we believe it is too early to make such a call as the risk of DPS defaults, if any, will be marginal, in our view. Based on sub-sale transactions to date a substantial amount of capital has been committed by investors in Sky@Eleven and the fact that transactions have not ground to a halt and are taking place at lower levels, suggests there is the propensity for the speculation to clear.