StarHub: Margin expansion raises the bar

Earnings up 3%, above expectations. In the three months to 31 Mar 09, earnings inched up 3% YoY to S$82.5m on the back of a 0.8% YoY contraction in revenue to S$530.6m. EBITDA margin, at 33%, is flat from a year ago but improved 0.9ppt QoQ. Rising margins for mobile (+0.8ppt YoY) and fixed network (+1.6ppt YoY) led to better than expected results. Strong cash flows. Free cash flow surged almost 4x to S$115.3m (6.7S¢/share) due to improvement in working capital. As a result, Net Debt-to-EBITDA improved to 1.05x, from 1.25x a year ago. Its target is 1.5-2x, which suggests room for capital management. But given the tight credit conditions, this is unlikely to happen. Capex, at 10% of revenue, remains comfortably in check.

OpCo win shaves fears. StarHub, which derives the largest portion of its revenue from broadband among the three telcos, is deemed to be the biggest loser when it comes to the National Broadband Network (NBN). But its OpCo win would have partially alleviated such fears. Moreover, NBN will likely lend a boost to its commercial business, which currently accounts for 20% of revenue.

Confident of snagging EPL rights. Investors have also been worried whether StarHub can retain the English Premier League rights for the 2010-12 seasons. When probed, CEO Terry Clontz appeared confident of winning the rights, claiming that a bidding strategy is already in place. We have assumed that StarHub would win the race by paying 50% more than what it paid three years back. He further believes that incremental costs will be covered, and thinks that analysts who have assumed lower margins may be too conservative.

Earnings estimates, target price raised. We have raised our earnings estimates by 4.2% to S$310.9m in FY09 on the back of improving margins. Dividend yield, at 9.2%, remains the highest among the telcos and the best among the STI components. We derive a target price of S$2.39 based on DCF (previously S$2.35), which implies an upside of 22.5%. StarHub remains our top pick and only BUY in the telco sector.

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StarHub : Commendable 1Q09 Results

1Q09 results within expectations. StarHub reported its 1Q09 results last night, with revenue down 0.8% YoY at S$530.6m, almost smack on our S$530.0m forecast, while net profit rose 3.1% to S$82.6m, or shy of our S$82.9m estimate; this included a tax credit of S$0.8m due to the corporate tax rate cut from 18% to 17%. On a sequential basis, revenue fell 1.1%, reflecting the economic slowdown, while net profit declined by 5.6%. But we note that the sharper earnings QoQ decline was due to a lower effective tax rate in 4Q08; otherwise, pre-tax profit rose 2.5% to S$101.5m, thanks to lower cost of sales and operating expenses. It also declared a dividend of S$0.045/share.

Drop in mobile revenue. On its key business segment, mobile revenue came off 3.1% YoY and 2.8% QoQ to S$264.7m, mainly due to lower revenue from its post-paid segment, which fell 4.8% YoY and 3.5% QoQ. Although it managed to grow its post-paid subscriber base by 9k users, we note that ARPU (average revenue per user) eased from S$71 in 4Q08 to S$67, hit by lower voice usage, IDD and outbound roaming services, while monthly usage also dropped from 469 to 442 minutes. A higher mix of customers on the discounted MaxMobile Data plans also had a diluting effect on post-paid ARPU. On the other hand, pre-paid revenue rose 2.7% YoY (down 0.5% QoQ), as the base grew by 40k to 914k users, though ARPU slipped from S$25 in 4Q08 to S$24. Mobile EBITDA margin improved from 36.6% in 1Q08 to 37.4%, thanks to lower acquisition cost and quantity of equipment sold.

Guides for stable service revenue. StarHub is guiding for stable service revenue (excludes non-core equipment sales), which management considers as "recurring revenue". Earlier, management guided for a low single-digit growth in total revenue. On the other hand, it has bumped up its service EBITDA margin from 31% to 32%. It has also kept its capex guidance to 11% of operating revenue. More importantly, based on its projected profitability and cash flow, StarHub intends to continue to pay S$0.045/ cent dividend every quarter, totalling S$0.18 for the full year. Maintain BUY. Overall, StarHub posted a pretty commendable set of results, despite the economic slowdown. As 1Q09 results were well within expectations, we are leaving our FY09 estimates intact; we may see room for upward revision should the economy recovers faster than expected. Maintain BUY with S$2.88 fair value.

Wilmar - ROEs are higher than they appear; retain Buy

On a reported basis, Wilmar’s ROEs are at the low end of the sector and appear to be on a declining trend from when the stock was listed in 2006. However, we believe the company’s ROE is understated due to non-cash intangibles from its merger in 2007, and is not representative of Wilmar’s cash returns or the returns on incremental investments.

We estimate underlying 2009E-2010E ROE at 23% (vs. reported ROE of 15%-16%), and our analysis indicates that incremental investments in Wilmar’s core merchandising and refinery, consumer products and plantations divisions could generate returns as high as 27%-86%. The market has seemingly been concerned that Wilmar’s downstream margins have been boosted by unsustainable directional trading. We disagree, as we believe there has been a significant change in the competitive structure of Wilmar’s key downstream businesses, while our analysis of similar agri-processing businesses worldwide indicates margins are not only sustainable but may have upside risk over the long term.

On an adjusted basis, Wilmar’s 2010E underlying ROE and CROCI move up to the top quartile of comparables in the Singapore market and plantations sector, while “reported” figures put Wilmar in the middle to last quartile. This could have positive implications for the company as investors tend to reward stocks in the top quartiles with premium valuations. Our new 12- month target price of S$6.50 (up from S$4.70) is based on 15X CY10E P/E, comparable to its historical 6X-19X trading range (since listing) and at a 15% premium to the Singapore market average. Our DCF-based SOTP is S$7.40/share. We reiterate our Buy rating and add it to our Conviction List.

Key risks are sharp decline in CPO or oil price; adverse government policy in China.