Still shining in 2Q

1H12 earnings were 4% and 9% above CIMB's and consensus estimates, respectively, due to margin surprise and we consider it in line as we expect margins to moderate in 2H due to higher handset subsidies and competition. StarHub maintained its outlook for FY12.

But it nudged its capex up as it is accelerating its LTE rollout. Maintain DCF-based target price (WACC 7.9%/LTG 1.4%) and Outperform call given its higher dividend potential as its net debt/EBITDA of 0.5x is its lowest since 2Q06. Hence, StarHub remains our top Singapore telco pick.

2Q earnings highlights

StarHub's operational performance was robust with service revenue rising 2% qoq and 4% yoy and EBITDA margin gaining 1.5% pts yoy and 0.4% pts qoq. This is mainly due to a 1.3% qoq decline in operational costs, thanks to lower marketing expenses and cost of handsets.

However, a few red flags:

1) 2Q prepaid revenue fell 2% qoq and 5% yoy due to lower ARPUs and fewer subscribers as users switched out after promotions expired,

2) the number of pay TV subscribers fell 0.2% qoq and yoy as customers churned out after short-term promotions expired, and

3) broadband user numbers also dipped 0.2% qoq as they left for cheaper offerings by new entrants riding on NGNBN.

Margin pressure in 2H

StarHub maintained its EBITDA margin guidance of 30% despite 1H's coming in at 32% because it expects margins to come under pressure when the new iPhone is launched in 4Q. It expects the device to be very popular given the widely-anticipated radical upgrades and new features.

Maintain outlook, nudging up capex

Starhub maintained its FY12 outlook and kept its 20 Scts DPS. We are still optimistic about its dividend upside potential as net debt/EBITDA is at its lowest since 2Q06. However, it has revised up its capex guidance from "below 11%" of revenue to "about 11%". It plans to accelerate its LTE rollout in 2H12, ahead of the release of new LTE handsets.

The New iPhone Cometh

2Q could be all she wrote as a new iPhone looms. StarHub will report 2Q12 results on 8 Aug and earnings should rise on seasonal strength. The stock’s continued rise is a good chance to take profit, in our view, as the launch of a new iPhone in 3Q12 can be expected to depress margins in 2H12. Also, yields have been compressed to historical lows and we do not expect upside in dividends given potentially heightened capital commitments next year for BPL and 4G spectrum cost. The important factors to look out for are EBITDA margin, Android handset mix, pay TV content cost and management tone on dividends. Finally, do keep an eye on the Samsung/Apple legal tiff as it is likely to impact future phone prices and telco subsidies. SELL.

2Q12 usually the strongest quarter but iPhone coming. Given benign competition during the quarter, we expect service revenue to grow YoY and QoQ, driven by mobile and Pay TV, which had the benefit of Euro 2012 revenue in June. Topline is expected to grow 5% YoY to ~SGD600m while net profit should rise 15-20% YoY to SGD90-95m, aided by better margins from lower subsidies, fueled by higher Android sales. However, 2H12 is expected to be hit by lower margins given the impending launch of a new iPhone.

The following are the most important numbers/factors to look out for.

1. EBITDA margin. We expect a YoY rise on higher mix of Android handsets. 30-32% would be expected but below 30% would disappoint, not that this matters much for the rest of the year. With the rumor mill fingering a Sep 12 launch for iPhone 5, we can expect all the telcos to suffer a margin crunch in 4Q12 and 1Q13. Despite overseas telcos’ attempts to break away from the margin-killing phone subsidy model, this is unlikely to happen in Singapore for the foreseeable future.

2. Android handset mix. Android handsets accounted for 50% of all handsets sold in 1Q12, up from 25% before. M1 said its Android mix in 2Q12 was 70% so we would not be surprised if StarHub reports a similar number. A range of 60-70% would be within expectations, while anything below 60% would be worrying. However, we think anything below 70% is unlikely as StarHub’s SmartSurf data-bundled mobile plans and MaxMobile stand-alone data plans are highly attractive.

3. Pay TV content cost. StarHub recognised the cost of the UEFA Euro 2012 soccer tournament in 2Q12, which hopefully was sufficiently matched by subscription, advertising and sponsorship revenue. We do not expect any negative surprises as it started selling subscriptions three months ahead of the matches, and mioTV viewers would also have been able to subscribe via cross-carriage. More importantly would be any new updates on the upcoming BPL auction in Sep/Oct 2012.

4. Dividends. While we expect 2Q12 DPS to remain at 5 cents a share and FY12 full year dividends at 20 cents a share, we would watch out for the tone of management’s commentary on future dividends. At this point, we expect the cost of BPL and 4G spectrum rights, payable next year, to reduce management’s willingness to consider raising its ordinary dividends. Management has also previously ruled out the possibility of one-off capital distribution.

Market is pricing 21 Scts DPS

• StarHub might report 2Q12F earnings of S$95m, up 23% y-o-y and 12% ahead of market expectations.

• Annual savings of S$20m due to the absence of EPL rights might disappear going forward.

• FY12F/13F raised 4% each, TP raised to S$3.50 as we switch to DDM with expectations of 21 Scts annual DPS. Maintain HOLD.

2Q12F earnings likely to be ahead of market expectations. In mid-August, we expect StarHub to report 2Q12F earnings of S$95m (23% y-o-y & 8% q-o-q). This should be 12% ahead of consensus expectations of S$85m on the back of the increasing popularity of Android phones which need lower subsidies than iPhones. 2Q12F includes the Euro Cup matches, however, and we expect the Euro Cup to be neutral to slightly negative. We have conservatively raised our FY12F/13F earnings by 4% each as the potential launch of iPhone5 could hurt earnings in the 4Q12F.

Two possible scenarios for English Premier League rights in September 2012. Neither one of the players has an incentive to bid higher for exclusive rights due to cross-carriage regulations. There are two possibilities here depending on what is acceptable to the Premier League. (i) Both players place a common joint-bid; (ii) Each player bids on a non-exclusive basis in order to avoid cross-carriage. In either case, each player has to incur some cost of owning the content rights. We estimate that StarHub has benefitted S$20m annually due to the absence of EPL costs and these benefits could disappear going forward.

Maintain HOLD with higher TP of S$3.50. We switch from DCF to DDM assuming 8% cost of equity, 2% long-term growth rate and 21 Scts DPS. With net debt to EBITDA of 0.5x, lowest amongst three telcos, StarHub could possibly raise regular dividends slightly. Management has ruled out special dividends though, given the EPL bidding ahead and the spectrum auction in 2013.

It’s Been A Stellar Ride

Time to say goodbye. Our long-standing buy call on StarHub has been rewarding. However, it is time to say goodbye and we advise clients to take profit. The stock has raced to an all-time high amidst the current risk-off environment and its dividend yield has compressed to the lowest level since listing. Going by our DDM model, the share price has already discounted a 20% rise in dividends, but our original expectations of higher dividends may be dashed by an upcoming 4G spectrum auction in 2013. Management has also indicated there will be no capital management or reduction initiatives. Assuming dividends stay flat at SGD0.20 a share, our DDM-derived target price is SGD3.04 or 15% below the current level. SELL into the current strength.

Stock is overvalued if dividend stays put. StarHub has almost reached our DDM-derived TP of SGD3.64, which had assumed a 20% rise in annual dividends to SGD0.24 a share. However, the 4G spectrum auction in 2013 may lead to a rise in cash commitment next year, which could reduce the company’s willingness to increase dividend payout. If dividends stay put at the current SGD0.20 a share, the stock is now overvalued, with a DDM-derived TP of SGD3.04.

Spectrum cost to push up 2013 cash needs. Using past auctions to provide a pricing benchmark, StarHub may need to pay SGD110-131m for refarmed 4G spectrum. An auction is likely to be held in 1H 2013. This could bump up 2013 cash requirements by 43-51% and push 2013 net debt/EBITDA from 0.63x to 0.78-0.81x. While this should not endanger its current SGD0.20 DPS, it may undermine our original thesis that StarHub can afford to increase its dividends.

Absolute valuations also difficult to justify. At the current level, StarHub is yielding just 5.6% on its ordinary dividend, the lowest since it was listed in 2004 and started paying dividends in 2005. The spread between dividend yield and the 10-year Singapore government bond yield has also narrowed to its tightest level yet, a mere 400bp, since the bond itself was issued in 2007. Dividend yield is also barely hedging against domestic inflation of 5% (as at May 2012).