Singtel - Optus rebound not in the price

Investor sentiment towards Optus remains poor so far, which is perhaps not surprising considering that mobile margins have plummeted from 40% in FY3/05 to around 27% YTD. Even so, we view ongoing market consolidation as a watershed event that should lead to a rebound in Optus’s margins to 30% by FY3/10, and this should drive a re-rating of SingTel, in our view. We raise our target price to S$3.10 (from S$2.95 previously) and reiterate Outperform rating on the stock. SingTel continues to be a top pick in both our regional telecom and regional strategy model portfolios.

Optus to benefit from Voda-Hutch merger: We view the opportunities for Optus from the Vodafone-Hutch merger as material in the short to medium term, and this is occurring at a time when Optus has positive momentum in the industry. We are raising our fair enterprise value estimate for Optus by 12% based on 8–13% upgrades in FY3/10–11 EBITDA.

Singapore – lower tax drives minor upgrade: The lowering of the corporate tax rate from 18% to 17%, together with the consolidation of the recently acquired IT services unit, could drive minor valuation and FY3/10–11 revenue (~12%) and EBITDA (~0–2%). Recessionary conditions, the effect of the government’s broadband project (NBN) and potential pay-TV price competition are key issues for the Singapore market. We think new-entrant risks through the NBN process are low because only an estimated 13% of retail broadband users are on high-end plans (>10Mbps).

Indonesian recovery thesis on track: Results from Indonesia’s No. 3 player Excelcomindo (EXCL IJ, Rp1,000, OP, TP: Rp1900) confirm our analyst Ken Yap’s thesis that smaller players are getting increasingly marginalized in the market as access to capital is curtailed. Telkomsel’s (unlisted) recovery appears to be back on track as reflected in 12% sequential QoQ growth in service revenues (vs -11% QoQ for EXCL).

We are raising our FY3/10–11 EPS estimates by 1.2–2.4%. 12-month price target: S$3.10 based on a Sum-of-Parts methodology. Catalyst: Optus's margin recovering to 30% in FY3/10.

The key elements of our bullish thesis – an inexpensive core business, value accretion for investment holdings as late entrants face financing issues and safety in the strong balance sheet and cash-backed 4–5% yield – remain firmly intact, and we reaffirm our Outperform rating. Our sum-of-the-parts derived target price translates to a FY3/10 PER of 13.5x. SingTel’s valuation appears to be attractive based on our forecast of a 10% FY3/09–12 EPS CAGR.

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