StarHub (HOLD Target Price: S$4.25)

We estimate revenue CAGR of only 1.9% over 2013-15. Broadband will come under pressure from competitive NBN prices, and we see little growth for pay-TV as SingTel beefs up its content offering. Mobile should get a boost from tiered data plans, but Singapore is a very mature market. The bright spot is fixed network services, leveraging NBN.

We forecast decent EBITDA CAGR of 5.8% over 2013-15 on NBN grants (ex-NBN grants: 4.4%) and lower traffic costs. Supported by FCF, annual DPS looks sustainable at S$0.20-0.22 (yield: 4.7- 5.2%). To achieve a more optimal capital structure, we assume StaHub will declare a special DPS of S$0.25 in 2014, taking net debt/EBITDA to 1.0x by the year-end. Average 2013-15E yield is an attractive 6.8% pa. special dividend may be declared in 1H14, than in 2013.

StarHub?s new CEO and CFO may opt to conduct a thorough review of the business before deciding how much excess cash to pay back to shareholders. Strategy-wise, we expect the CEO to focus on the corporate data services business, given his IT background and the opportunities from greater connectivity to office buildings via NBN.? BNP Paribus    ...last: $4.23...

StarHub  (SGX: CC3) had been the sole pay-tv operator in Singapore until July 2007, whenSingTel  (SGX: Z74) entered the fray with its Mio TV service.

Kicking off the new season

In 2009, SingTel pulled off a major coup by winning the rights from StarHub to broadcast the Barclays Premier League (BPL) games in Singapore. As shown from the table below, StarHub has been losing customers and revenue for its pay TV subscription since 2009.

(Source: StarHub Annual Reports)

With the new cross-carriage rule that is likely to kick in for the new BPL season starting August 2013, StarHub may win back some of its previous customers. But we’ll have to wait and see what happens.

The pay-tv segment is also seeing keen competition from illegal downloads and free online streaming of movies and shows. To counter that, StarHub is producing its own proprietary content such as “Lady First  – Singapore” that is less likely to be pirated.

It is noteworthy that StarHub is coming up with new ways to lock in customers but the question begs: How popular are these shows as compared to those overseas content that can be downloaded online for free?

Competitive threat

As for the broadband services segment, more people are going on board the fibre broadband bandwagon, which was launched recently. Since 2011, more companies are springing up offering fibre broadband services to consumers – increasing competition for StarHub. Please refer to the table below.

(Source: StarHub Annual Reports and own calculation)

It can be seen that the percentage increase year-on-year has been falling consistently since 2007 and from 2011 to 2012, this number dipped significantly. It only added 4,000 households in 2012. This can be on the back of increasing competition from its fledgling competitors.

Too much debt

Quantitatively, StarHub’s debt-to-equity ratio is extremely high at 40.6 and the Return-on-Equity is extremely inflated at 826% due to leverage.

The dividend payout ratio is 0.958. This shows that StarHub is paying too much of its profits as dividends and is retaining too little to grow its business.

StarHub is valued at 19 times profit. It is also priced at 50 times its book value. That is not exactly cheap by any measure. By comparison, SingTel is valued at 16 times profit while the price-to-book is also lower at 2.4. In my opinion, SingTel should be trading at a premium to StarHub, since it is a much bigger company. 

Kaching!  That is a sound that  StarHub’s (SGX: CC3) shareholders should be familiar with. After all, the telecom operator has made quarterly dividend payments its hallmark since the second quarter of 2005, providing investors with steady, regular income.

At its current share price of $4.05, and with management projecting a total of $0.20 in dividends for this year, the company’s forward dividend yield is 4.9%. That’s an attractive return, given that it’s almost twice the 2.5% yield that investors are getting in the broader market through the  Straits Times Index  (SGX: ^STI) tracker, the  SPDR STI ETF  (SGX: ES3).

Of course, an attractive dividend yield is only appealing if a company is able to keep handing out those cheques using cash that is generated from its businesses.

And on that count, StarHub is a cash-hub.

You need cash for dividends and StarHub makes plenty of dough

It’s been said that a picture is worth a thousand words. So, I’ll save you the trouble of poring through tables of numbers and let you check out the graph below instead.

That’s about as steady a free cash flow stream as you can get and signs are that StarHub’s future cash flow performance could be similar to its past.

A huge portion of StarHub’s revenue comes from subscription-based services – around 89% of 2012’s revenues, to be exact. Subscribers aren’t likely to change telecom providers if service standards do not deteriorate significantly, and that is within StarHub’s control.

So far, the company has not disappointed, as evidenced by the low quarterly customer churn rates of between 0.9% to 1.6% for 2012 and the first quarter of 2013, depending on the quarter and the service.

Low customer churn brings with it higher predictability for revenues and by extension, cash flows. This is advantageous for investors with a focus on steady, reliable income.

Neutralising the debt gremlin

At first glance, StarHub’s balance sheet is bloated with debt, as it is currently carrying S$688m in loans with only S$137m worth of shareholder’s equity.

Investing 101 states that high debt levels can create risks for shareholders. But for StarHub, it helps generate better shareholder returns –  a phenomenal 293% return on equity, to be exact. Shareholders are in a win-win situation here by getting regular income as well as seeing undistributed cash ploughed back into the company to earn impressive returns.

Circling back to debt, out of the S$688m that StarHub owes to other parties, S$220m is not due for repayment for another nine years – September 2022. So that’s a long-time away before there are any worries. Not much is known of the remaining S$468m, so there could indeed be risks there. But, the company’s excellent cash flows should help to neutralise some of that risk.

StarHub’s moving up?

With reliable cash flows and smart use of debt to generate superior returns on shareholders’ equity, it’s possible for StarHub’s dividends to resemble salaried workers’ monthly pay-checks, i.e. very good news for income investors. And that’s the reason why the bull can charge through the bear’s den.