Good cash flow but earnings disappoint

At a Glance

• Net earnings of S$58m disappoints, as content costs increase and handset subsidies continue

• Free cash flow better than expected however, as capex of S$45m well below quarterly run-rate, plus working capital stays in positive territory

• Dividend payout of 5.0Scts, as guided; we remain skeptical on dividend sustenance beyond FY10

• Maintain Fully Valued call at TP of S$2.20

Comment on Results

While 2Q10 earnings of S$58m (up 36% q-o-q, down 25% y-o-y) recovered on a sequential basis, it still fell short of our expectation of around S$65m, largely because of higher than expected content costs of S$103m (up 21% y-o-y, 16% q-o-q), arising from the production costs and broadcast rights for the FIFA World Cup in June 2010, among others. Handset subsidies for iPhones continued to push up costs on a y-o-y basis as well, though equipment costs declined by about S$12m from 1Q10 levels. Mobile market share improved to 29.2% in 2Q10 from 28.4% in 1Q10.

Going forward, we continue to expect earnings recovery in 2H10, owing to lower handset subsidies and absence of one-off costs, and maintain our earnings estimates for FY10. Management continues to guide for i) low single digit revenue growth ii) 28% service EBITDA margins, and iii) a capex to sales ratio of up to 14%.

Recommendation

Low capex of S$45m in 2Q10 led to better-than-expected free cash flow of S$110m for 2Q10. An increase in payables for handsets also rendered working capital positive, boosting FCF. However, we believe a back-end loaded capex will lead to declining FCF in subsequent quarters. We still expect FCF to fall short of dividend commitments in future – if not in FY10 – as StarHub is committed to S$100m capex for NBN over 2010-12. Thus, we maintain our view that the 20Scts annual DPS may not be sustainable. Maintain Fully Valued; our DCF-based TP is unchanged at S$2.20.

2Q10 Results

• 2Q10 revenue of S$569.3m, net profit of S$58.1m

• Higher costs of smart phones, Pay TV content costs, staff costs, marketing and promotion expenses as well as repair and maintenance expenses

• Upgrade from Sell to Hold and raise fair value from S$1.92 to S$2.16

2Q10 results

StarHub reported 2Q10 operating revenue of S$569.3m (+6.9% y-y) and net profit of S$58.1m (-25.4% y-y). Revenue was 4.9% higher than our estimate of S$542.6m while net profit was 16.8% lower than our estimate of S$69.9m. It also announced an interim dividend of S$0.05 per ordinary share for 2Q10, which was higher than S$0.045 for 2Q09. Revenue increased mainly because of greater mobile and Pay TV services revenue. Net profit dropped because of higher costs of smart phones, staff costs, marketing and promotion expenses as well as repair and maintenance expenses. Furthermore, Pay TV content costs rose due to the broadcast of the FIFA World Cup 2010.

FY2010E Outlook

There is no change to StarHub’s expectation that the operating revenue growth for 2010 will be in low single digit. Furthermore, it expects to pay dividend of S$0.05 per ordinary share per quarter for this year. Moreover, it anticipates stiff competition in mobile, broadband and Pay TV for 2H10.

Upgrade from Sell to Hold and raise fair value from S$1.92 to S$2.16

As StarHub reported an improvement of 2.2% and 36.1% in 2Q10 revenue and net profit respectively compared to 1Q10 revenue of S$557.2m and net profit of S$42.7m, we upgrade our recommendation from sell to hold. We also raise its fair value from S$1.92 to S$2.16 based on the discounted cash flow (DCF) model. However, we continue to have doubts that it can sustain its dividend payout of S$0.05 per quarter in the long-term. This is because its earnings per share of S$0.0585 for 1H10 are less than the total dividends of S$0.10 for the same period.

Hopes for margin improvements

• In line; maintain UNDERPERFORM. 1H10 core profit matched our forecast at 46% of our FY10 figure but was below consensus (43%). We expect stronger quarters ahead as the initial flood of iPhone subsidies should dissipate, higher ARPUs from smartphones should begin to offset subsidies in subsequent quarters and Barclays Premier League (BPL) costs come off the books in 2H10. As expected, a 5-ct DPS was declared. We keep our earnings forecasts and DCF-based (WACC 9.7%) target price of S$2.14. We still expect de-rating catalysts from pressure on broadband ARPUs ahead of the NGNBN launch and potentially higher churns in pay TV following the loss of its BPL rights to SingTel. We prefer M1 for exposure to Singapore telcos for its potential capital management and our view that M1 will be the biggest beneficiary of NGNBN.

• Revenue rose 2% qoq and 7% yoy, led by strong performances in pay TV and postpaid, offset by lower equipment sales from lower handset volumes and a slight decline in prepaid revenue qoq. Thanks to the 2010 World Cup rights, pay-TV revenue rose a strong 8% qoq. Excluding this, revenue would have been down 1% qoq. Postpaid revenue grew 4% qoq, driven by roaming and IDD as well as rising contributions from data.

• EBITDA improved. As guided, EBITDA margins improved 1.4% pts qoq because of lower iPhone-subsidies. Margins, however, were dampened by one-off World Cup costs as well as higher content renewal costs which caused cost of service to rise 16% qoq. Marketing costs were also higher (+9.4% qoq), related to the World Cup.

• No change to 2010 guidance. StarHub has kept its guidance of low-single-digit growth in revenue despite a 6% yoy rise in 1H10 so far. It is conservative as pay-TV revenue could decline following the loss of BPL going forward. There was no change to its service EBITDA margin guidance of 28% despite 1H10’s 25% as it expects a higher ARPU uplift from smartphones to overcome handset subsidies provided for them. Also, the heavy loss-making BPL content cost would come off the books in 2H10. Also, no change to the minimum 20 cts/share DPS guidance or cash capex not exceeding 14% of revenue.

Pay TV and broadband churns, more competition in 2H10

• StarHub Ltd’s 2Q10 results were in line with expectations, we maintain a full year net profit fall of 16% YoY, with fair value at S$1.88 and a SELL rating.

• 2QFY10 net profit fell 25% YoY to S$58.1mil, bringing 1HFY10’s fall to 37% YoY. Expenses mainly outpaced revenue.

• Higher mobile subscriber acquisition costs at S$109 in 2QFY10 (versus S$79 in 2QFY09) and higher content costs from FIFA World Cup in June dragged earnings. StarHub launched iPhones on 9 December 2009, pursuing a high-end handset sales strategy.

• EBITDA margins on service revenues of 26% in 2QFY10 and 24% in 1HFY10 were much lower than 31.5% and 32% for the previous corresponding periods, respectively. As in 1QFY10, management claims the hit was due to one-off effects and guides for 28% in FY10F.

• At topline, mobile services grew 8% YoY in 2QFY10 (making up 54% of service revenues), and helped boost total service revenues up 5% YoY. Mobile subscriber growth was a healthy 11% YoY to a base of 2.1 million. Postpaid ARPU held up well at S$70, though prepaid ARPU eroded to S$21, against S$69 and S$23 achieved in FY09 respectively.

• With loss of media rights to Barclays Premier League (BPL), Pay TV segment has started to show initial effects. Churn rose to 1.2% from previous norm of 0.9%- 1%, and 2QFY10 as the first quarter showed no incremental adds in subscriber base. ARPU was up by S$1 from 1QFY10 to S$56 – but this boost was driven only by subscriptions to FIFA World Cup for June- July.

• Worst is yet to come from the end of BPL in 2H 2010 – we are expecting 10% of subscribers to drop out, and ARPU to end at S$48 for FY10F and S$43 for FY11F. However, 2H 2010 will see the effect of lower cost of TV content upon the expiry of BPL contract. As such, this will spur a recovery in EBITDA margins.

• Competition ahead of NGNBN launch continues to take its toll on cable broadband. Despite increased discounts and shift in mix to more lower value plans, there were no incremental adds to subscriber base – with churn rising to a new quarterly high at 1.6%.

• Despite the commercial launch of Nucleus Connect (wholesale operator in NGNBN) in 2H 2010, we think it is early days yet – to expect a big impact near term. All in, management is guiding for low single digit topline growth for FY10F.

• Management expects to maintain DPS of 5 cents Singapore per quarter. This puts current yield at attractive 9% p.a. However, with payout ratio exceeding 100% and projected Net Debt/EBITDA rising to 1.5x in FY11F, we feel maintaining DPS would be most challenging. With 20% share price downside till fair value, yield will be wiped out.

StarHub’s bottom line kicked by World Cup

Net profit for Q2 drops 25.4% from $77.8m to $58.1m

THE World Cup dealt StarHub a swift kick in the bottom line in the second quarter of this year, along with higher costs from subsidies for the iPhone and other smart phones.

Net profit for the quarter fell 25.4 per cent from $77.8 million to $58.1 million.

Even as operating revenue rose 6.9 per cent to $569.3 million in Q2, it was overshadowed by a 14 per cent – or $60.5 million – increase in operating expenses to $492.3 million.

For H1, net profit was down 37.2 per cent to $100.7 million.

Revenue for the same period rose 6 per cent to $1.13 billion, while operating expenses surged 16 per cent.

Earnings per share for Q2 and H1 were 3.39 cents and 5.87 cents respectively, down from 4.55 cents and 9.37 cents for the corresponding periods a year ago.

In May this year, StarHub and SingTel reached a deal with Fifa over the broadcast rights for the World Cup event, for an undisclosed sum.

While Fifa had put a $40 million price tag on the rights, speculation then had pegged the final sum to be about half that.

According to StarHub, the cost of the broadcast rights were expensed based on the number of matches aired.

With 56 out of 64 matches aired in June and the remainder in July, the bulk of the rights has been expensed for Q2.

Its cable television revenue for the quarter, however, grew the most across StarHub’s segments, with a 9 per cent rise to $109.6 million, year-on-year.

Excluding the revenue from the World Cup, average revenue per user per month would have been $2 lower in Q2, at $54.

StarHub’s mobile services revenue grew 8.2 per cent in Q2, year-on-year, to $294 million, while its fixed networks services revenue managed a 2.1 per cent increase to $81.6 million.

The broadband segment was the only one to shrink, its revenue dipping 1.8 per cent to $59.2 million.

The group is expecting to turn a corner on the subsidies for iPhones and other smart phones that have ratcheted up costs for both Q1 and Q2.

‘The benefits of the smart phone investments are beginning to come through in the Ebitda margins,’ said Neil Montefiore, StarHub’s chief executive officer.

Ebitda margins in Q2 gained 3.4 percentage points month-on-month, from 22.5 per cent in Q1 to 25.9 per cent.

For FY2010, StarHub expects to maintain an Ebitda margin on service revenue of about 28 per cent.

Its guidance on revenue growth for the year was a little on the conservative side – low single-digit range – partially due to its loss of the English Premier League (EPL) broadcast rights for the next three seasons, starting on Aug 14.

‘After Aug 14, there might be some customers who will want to move from us, but we’re not sure,’ said Mr Montefiore.

In H1, the customer subscriber base for its cable TV service held steady at 541,000 customers in both quarters.

Late last year, it had expected to lose 10 per cent of its cable TV customer base over the EPL loss.

On the controversial cross-carriage mandate front, StarHub said that it had submitted its feedback to the government and was still waiting for the outcome.

The cross-carriage mandate forces operators to share any exclusive content that they sign from March 12.

StarHub is maintaining its cash dividend payout of 5 cents per ordinary share per quarter, 20 cents for FY2010 in total.

The counter closed one cent lower at $2.33 in trading yesterday.