Android accounting impact
M1’s 2Q12 core net profit missed our forecast and consensus by 16% and 11% respectively due to the accounting of non-iPhone device subsidies. Despite lower earnings,M1 pledged to maintain absolute DPS. It declared a 1H12 DPS of 6.6 cts, unchanged yoy.
We maintain Neutral on M1 but raise our DCF-based target price by 14% to S$2.86 on: 1) lower subsidies given the rising popularity of the lower-cost Android devices vs iPhones and 2) lower WACC of 7.6% vs 7.9% to reflect its fairly attractive dividends. We also adjust our FY12-14 EPS forecasts by -7% to +3%. StarHub remains our top pick.
Profitability impacted by accounting
Although its cashflows are unaffected, M1’s margins were impacted negatively by its accounting treatment for Android devices where the subsidies are expensed vs being amortised over the contract period for the iPhones. We suspect that this impact will carry over to 3Q12 as the very popular Samsung Galaxy S3 had only a one-month impact in 2Q12 since it was launched in end-May. Android devices made up about 70% of the total devices sold in 2Q, a reverse from previous quarters where the iPhones dominated. However, we think margins should improve thereafter when: 1) the new iPhone is launched, typically in 4Q, and 2) the impact of the Samsung Galaxy S3 washes through.
Not surprisingly, M1 expects a “short-term” impact of handset subsidies on its profitability. It reiterated FY12 capex of S$120m. M1 views OpenNet’s 29% higher installation quota positively, but feels that it is insufficient to reduce the service activation period.
Despite net profit being weighed down by expensing subsidies, M1 pledged to maintain its absolute FY11 DPS in FY12, i.e. by raising its payout ratio. The company said that it planned to maintain its FY11 absolute DPS of 14.5cts for FY12. It declared an interim dividend of 6.6cts (80% payout vs 70% in 1H11).
2Q12 results highlights
The key highlights of the 2Q12 results were: 1) service revenues fell 0.7% qoq mainly dragged by lower international call revenues (-7.4% qoq); 2) service EBITDA margins fell by 2.1 ppts due to its accounting treatment for Android handsets; 3) IDD revenues were lower due to lower roaming and IDD prices, and 4) SACs fell by 12% qoq due to a higher sales mix of Android handsets vs iPhones.
Android devicesoffer better economics
During 2Q12, Android phones accounted for 70% of device sales, largely on the back of the Samsung Galaxy S3 which was launched on 29 May 2012. For the first time, Android devices sold outnumbered the iPhones. We expect earnings to be weighed down in the near term due to subsidy expense. However, longer term profitability and shareholder value should improve with consumer preference shifting to the Android devices given its lower costs and subsidies vs the iPhones while revenues are unchanged. This is illustrated in Figure 1 below.
M1 views the recent move by the IDA to increase the installation quota for NGNBN positively, but is still concerned that it is insufficient to meet the service delivery period of 7 days.
M1 has achieved a net add of 8K for its fibre subscriptions during 2Q12 (total of 39K subscribers). It currently has a market share of around 22-23%.
Lower IDD revenue
International direct dial (IDD) revenues fell 7% qoq and yoy because of lower roaming rates to and from Malaysia and a decline in IDD tariffs. However, M1 said that IDD margins were unchanged at 50% because of the lower international interconnect rates.