• Excluding National Broadband Network (NBN) fee, Australia business is likely to stabilise in FY21F; raise FY21F/22F earnings by 6%/8%.
• We estimate average free cash generation of 15Scts per SingTel share over FY20F-22F although divestments can help to sustain 17.5Scts dividend per share (DPS).

Singtel Offers 18% Upside Potential With 5% Yield

• Associates’ pre-tax profit growth of 40% in FY21F, led by Bharti’s turnaround is likely to override the core weakness in Singapore and Australia. We project SingTel (SGX:Z74) to deliver earnings CAGR of 5% over FY20F-22F coupled with 5% yield. The stock has declined 11% since weak 3Q20 results.
• Based on the market price of associates, the holding company (HoldCo) discount has expanded to 22% vs 15% average over the last 4-years.

Australia Consumer & Enterprise EBITDA on the Mend

Singtel’s 9M20 core EBITDA (ex NBN) has declined by 12% mainly due to cost-mismatch at Optus.

• Over 9M20, Optus’ mismatch between equipment sales and cost of sales contributed an adverse impact of ~A$175m (see chart in attached PDF report). The increase in traffic costs of A$107m over 9M20 added on to Optus’s woes, creating a further drag on core EBITDA.

We raise FY21F core EBITDA by 4% from our previous projections as we expect handset business in Australia to improve.

• Handset business is a very thin-margin business and Optus suffered in 9M20 due to its expensive inventory of handsets which it had to sell at a loss (as per our estimates). Most customers preferred to buy handsets from retailers instead of telcos after handset subsidies were removed.
• We think that Optus would be more cautious in FY21F and not build up excess handset inventory in FY21F. We hope to see A$170m benefit to FY21F Australia EBITDA as most of the adverse impact from handset business in FY20F disappears in FY21F. However, Australia EBITDA will still suffer from ~A$300m drop in NBN migration fee in FY21F and another ~A$100m rise in traffic costs in FY21F as more customers switch to NBN.

National Broadband Network (NBN) payment receipts to decline in FY21F by ~A$300m after peaking in FY20F.

• NBN Co. has been making payments to Telstra and Optus for the migration of customers off their legacy networks to the new NBN network. Under an agreement, Optus will share spectrum within its Hybrid Fibre Co-axial (HFC) network with NBN Co before the network builder eventually takes ownership of the asset. NBN will progressively take ownership of the HFC network, with Optus obligated to use the NBN infrastructure for the next 15 years from 2014 to 2029.
• Majority of Optus’s HFC customers have already been migrated to the NBN network, with only 168,000 customers remaining on the HFC network as at the end of 9M20. As at the end of 9M20, Optus has migrated 302,000 HFC customers out of 470,000 for a total consideration of A$1,128m from NBN Co.
• We estimate that Optus is likely to receive a total NBN migration revenue of ~A$348m over FY21F as all the remaining HFC customers are migrated to the NBN.

Enterprise segment to benefit as NBN Co. backs out of directly signing up enterprise customers.

• Enterprise revenues of Optus reported consecutive declines from as far back as 1Q19, declining by ~A$90m from 1Q19-3Q20 due to intense competition with new entrants re-selling NBN in Australia coupled with NBN Co. entering into direct deals with enterprises, competing with telcos directly for the acquisition of enterprise customers. Fall in Australia enterprise revenue hurt the overall Group revenue and barring Australia’s revenue, the Group enterprise revenue remained stable in 3Q20. Enterprise EBITDA continued to be vulnerable on waning revenue and plunged by 55% y-o-y to A$22m.
• In January 2020, NBN Co. announced that it had yielded to industry complaints over its enterprise and government businesses, declaring that the network provider will stop contracting directly with enterprise and government customers and instead share sales leads with the retail service providers.
• NBN Co is expected to publish a consultation paper on how it will manage enterprise and government relationships and transfer leads to telcos and other retail service providers by 7 February 2020. With this step, we believe that the enterprise segment of Optus will see a boost in revenues and EBITDA from FY21F onwards.

Our Take on Dividends

• FY20F-22F free cash flow (FCF) can easily support 15Scts dividends per share. SingTel’s FCF from the core business is likely to decline to S$1.7bn in FY21F from S$2.1bn in FY20F, mainly due to S$300m drop in NBN migration fee in Australia and weakness in enterprise business in Singapore. There will be interest expenses of S$0.5bn annually to be deducted each year.
• Dividends from associates are likely to be S$1.3bn-1.4bn similar to S$1.3bn received in FY20F. So overall, S$2.4- S$2.5bn (14.7-15.6Scts per share) should be available for distribution to the shareholders, in our estimates.

Singtel’s current credit rating is under pressure unless Singtel reduces its net debt by S$2-2.5bn via divestments.

• SingTel's leverage, calculated by Moody’s Investor Services as adjusted net debt/EBITDA (based on cash dividends from associates being added back to core EBITDA), has risen due to a drop in core EBITDA. Moody’s has indicated that the rating of A1 with a negative outlook assigned in March 2019 could be downgraded if SingTel's operating and financial profile continues to remain weak, such that adjusted net debt/EBITDA remains in excess of 2.0x, or EBITDA margin remains below 30% on a sustained basis.
• SingTel’s net debt to EBITDA is well below the threshold of 2.75x required for the lowest investment grade rating.
• SingTel has non-core assets worth over S$5bn, which can be divested in the near-term.

We value Singtel’s data centre business at S$2.0bn or S$0.12 per share.

• Pure-play data centre (DC) operators fetch an average EV/EBITDA valuation of ~20x while telcos fetch a valuation of ~7x, suggesting 60-70% undervaluation of DC assets held by telcos. We estimate that its portfolio stands at over 1.5msf worldwide based on available data.
• Assuming 45% utilisation (generally ranges from 30- 50%) and mid-point psf (Hong Kong and Singapore: S$3,700 psf, Australia: S$2,400 psf) established from peer comparison, we value SingTel’s portfolio at S$2.0bn.

We value Singtel’s digital businesses, comprising Cyber-Security and Digital Life at S$2.2bn or S$0.13 per share.

• The CyberSecurity segment is valued at S$818m, based on enterprise value/revenue (EV/revenue) of 1.3x, pegged to a 20% discount to peer average to account for the lack of profitability of SingTel’s cyber-security operations. The Digital Life segment, which largely comprises the Ad-Tech firm Amobee group, has been valued at an EV/Revenue of 1.05x, a 30% discount to the average valuations of recent acquisitions in the Ad-Tech space

We estimate that Singtel’s stake in Netlink NBN Trust is worth ~S$1bn based on the latest market value.

• SingTel holds 24.99% stake in NetLink NBN Trust (SGX:CJLU) and the company will require regulatory approval to divest its stake in NetLink NBN Trust.

Source: DBS Research - 5 Mar 2020