Sunday, July 21, 2013

Telecommunications companies: Dividends, defensive businesses and growth opportunities lure investors back to telcos

Telecommunications companies: Dividends, defensive businesses and growth opportunities lure investors back to telcos

Written by Joan Ng  
Monday, 15 July 2013 20:37
After the recent market rout that sent investors running from yield plays, it seems that telecommunications stocks are back in favour. In a recent report, Nomura notes that Asian telcos gained 3% in June and 28 out of the 34 telcos under its coverage outperformed their local index benchmarks. In fact, telecoms and healthcare were the only sectors that ended last month in positive territory. And, year-to-date, telco stocks have performed the second best, with an 11% gain.

These numbers stand in contrast to a picture painted last month that dividend-paying stocks such as real estate investment trusts (REITs) and telcos would lose favour with investors as the yields on long-term bonds rose. In expectation of cuts in the US Federal Reserve’s monthly bond-buying programme, yields on 10-year US Treasuries have spiked over the last six weeks. The telcos and REITs, meanwhile, saw their share prices fall.

Indeed, the FTSE Straits Times Telecommunications Index, which tracks the local telcos, declined 13.5% from its peak this year of 1,064.6 points on May 20 to hit 920.6 points on June 24. In comparison, the Straits Times Index lost 11% from its peak on May 22 to its low on June 24.

Since then, however, the telecoms index has risen 6.4% while the benchmark STI has gained 3.4%. Leading the gains has been Singapore Telecommunications, which has seen its stock rise 6.6%. M1 is not far behind, up 6.5%, and StarHub is trailing at 4.5%.

Some of SingTel’s gains may be traced to the recent award of telecoms licences in Myanmar to Norway’s Telenor and Qatar’s Ooredoo. Sing- Tel had submitted a bid for a licence and had been considered a preferred candidate, due to its strong regional presence and deep experience in emerging markets. In a report, Nomura says the Myanmar licence, while appealing on a long-term basis given the low penetration rates in the country, would also have required significant capital commitments. Without a licence in Myanmar, Nomura now thinks there is potential for sustained increase in dividends or special distributions.

Deutsche Bank analyst Alan Hellawell also says, in a client note, that a Myanmar mobile venture would likely have been loss-making for SingTel for at least five years. “Meaningful earnings accretion may materialise only towards the end of the 15-year licence period.

But the key uncertainty is the investments that would be required to build a mobile business in Myanmar,” he writes. “Assuming cumulative capital expenditure of US$1.5 billion [$1.91 billion] to US$1.6 billion [front-end loaded], it is possible the Myanmar business could have been free cash flow dilutive to SingTel over the medium to long terms. We believe the Myanmar venture would have at best been marginally accretive to SingTel’s enterprise value, but more likely mildly dilutive.”

Stock-specific catalysts aside, the local telco industry also appears to enjoy some favourable sector dynamics. For one thing, all three local telcos have begun to roll out nationwide long-term evolution (LTE) coverage. As users upgrade to this faster mobile broadband network, they are being made to sign contracts that bundle smaller amounts of data for the same price. The three local telcos have guided that this re-pricing of data should generally result in a small number of customers paying slightly more because of their heavier usage. And it is also expected to lead to better network utilisation and, ultimately, better investment efficiency on the part of the telcos.

The strong bounce in the share prices of the telcos also illustrates the resilience of this segment. Besides dividend yields ranging from 4.2% to 4.8%, and steady cash flows from stable businesses, the telcos also enjoy prospects for revenue growth. As more data, software and business processes move on to the cloud, Internet usage over both fixed lines and mobiles is becoming increasingly important for both individuals and businesses. Harnessed correctly, this rise in demand for connectivity could be a boost to revenues and earnings.

All this Internet-related activity is also giving the telcos opportunities to branch into new business segments. StarHub, for instance, is investing in big data intelligence. SingTel, meanwhile, has established an investment arm that looks out for promising technology ideas. These new ventures may be risky because they are unproven. But the investments being made are small, with the potential for big returns.

Are the three telcos likely to keep rising from here? Lim Say Boon, managing director and chief investment officer at DBS Private Bank, says that in the months ahead as liquidity unwinds, the market is likely to mature into one that emphasises company fundamentals and performance. Earnings, balance sheet strength and cash flows may begin to matter more than liquidity flows and yield spreads. That could mean a greater divergence in the performance of the three telcos, as each faces a different challenge.

Analysts expect SingTel’s earnings to be weaker in the coming quarters because of its significant operations in Australia. The Australian dollar has weakened some 8% against the Singapore dollar this year and expectations are for it to continue trending down. DBS Vickers is also worried about SingTel’s Indian operations, which have underperformed in recent quarters, and losses from the company’s new digital business.

Deutsche Bank, meanwhile, sees StarHub having to deal with longer-term pay-TV concerns. The company is being challenged by SingTel in this business and analysts worry that StarHub’s ability to attract and retain customers by bundling TV with mobile and home broadband could be eroded.

Most analysts expect M1 to be a key beneficiary of the re-pricing of mobile data because it has a higher leverage to the mobile business. For a long time, M1 was the only mobile pure play in the local market. It has since begun offering home broadband services over the Next Generation Nationwide Broadband Network, an open-access high-speed fibre- based network that runs to most homes and offices in the country. M1 says its broadband business is already profitable and that it is gaining market share and scale. However, Credit Suisse analyst Chate Benchavitvilai also notes that M1 “remains at a disadvantage to the two operators” because many of its subscribers generate low revenues and because M1 is not able to bundle TV content with its mobile or broadband services.

According to Bloomberg data, the average 12-month price target for SingTel is $4 while the most bullish target, from Nomura, is $4.50, representing upside potential of 6.7% and 20%, respectively. For StarHub, analysts are slightly less bullish. The average price target is $4.18, just 0.7% higher. CIMB Research has a price target of $4.52, which represents an upside of 8.9%. The most bullish expectations have been reserved for M1, long an underperformer and also the smallest of the three telcos. Its average is $3.29 and the top price target, from Deutsche Bank, UOB Kay Hian and Macquarie, is $3.72. That represents upside potential of 4.8% and 18.5%, respectively. These numbers don’t include the returns from the steady dividends that telcos pay. And, over the long run, that’s a return that investors shouldn’t disregard

Publish date: 17/07/13

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There’s no such thing as defensive stocks.Every stock can be defensive depending on what price you pay for it and what value you get,
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