DBS Group Research analyst Sachin Mittal has named StarHub CC3 as his new telecommunications (telco) sector pick after the telco is expected to benefit from its lower transformation costs. The analyst has a “buy” call for StarHub with an unchanged target price of $1.54.
StarHub, Singapore’s second-largest telco player, is building a digital platform with multi-cloud capabilities through its DARE+ transformation programme. “Meaningful realisation” is expected to start from FY2025 onwards after costs taper off, says Mittal in his report on the telco dated Oct 15.
The analyst notes that StarHub’s transformation-related operating expenses (opex) are expected to drop to $12 million in FY2025 ending Dec 31, 2025, compared to FY2024’s opex of $23 million. Costs are projected to decline to zero in FY2026.
The telco has previously indicated that it expects to incur about 90% of its transformation costs of $270 million in FY2024. The remaining 10% will be expensed in FY2025. As such, Mittal has projected StarHub’s transformation costs to come in at $52 million in FY2024 and FY2025, which comprises 55% of capital expenditure (capex) and 45% of opex.
“This transformation has also led to lower maintenance capex over the last three years, leading to a drop in depreciation and finance costs, boosting earnings growth,” Mittal writes. As a result, the analyst is projecting a 10% earnings compound annual growth rate (CAGR) of 10% over FY2024 to FY2026 and a yield of less than 6%.
Another factor in StarHub’s favour is its medium-term drivers such as cybersecurity and managed services. Cybersecurity, which made up 16% of StarHub’s FY2023 revenue, is seen as the telco’s “key growth driver” with revenue expected to grow at a CAGR of 21% over FY2024 to FY2026 led by Ensign.
“StarHub’s cybersecurity venture is a profitable business (excluding D’Crypt) and… we expect the cybersecurity business to go public by FY2024 [or] FY2025, as it achieved operating profit breakeven in FY2023,” says Mittal.
“We assume two to three times price-to-revenue for Ensign in FY2024. The enterprise value of Ensign is expected to be $0.73 billion - $1.1 billion,” he adds. “StarHub can claim $406 million - $610 million for its 55.73% stake, equating to 19% - 28% of StarHub’s market cap of $2.2 billion.”
Additionally, managed services is another growth driver as StarHub has plans to launch cloud service for enterprises in FY2025 forecasts. Their cloud services can be customised and powered by external vendors on the backend.
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“Under our coverage, only StarHub has the potential to provide such cloud services in Southeast Asia due to its DARE+ transformation plan,” says Mittal.
At this point, Mittal prefers StarHub in the near term as it is trading at 12 times its FY2025 forecasted price-to-earnings ratio (P/E). This is at a 42% discount to Singapore Telecommunications Z74 (SingTel), despite offering a similar CAGR of 11% over FY2024 to FY2026 forecast, he notes in his sector report issued on the same day.
Compared to Singtel, Mittal notes that StarHub offers similar earnings growth but with a higher yield of 6.2% and 6.8% for his FY2024 and FY2025 forecasts, respectively. StarHub has an estimated dividend per share (DPS) of 7.4 and 8.2 for FY2024 and FY2025 forecasts, respectively.
Mittal’s target price “conservatively” values Ensign at 23 cents to 35 cents per share at two to three times StarHub’s FY2024 revenue with the mid-point at 29 cents per share.
“We believe StarHub should re-rate from 12 times FY2024 P/E ratio to 17 times, still lower than its last five-year average of 18 times,” he says. StarHub’s share buyback plan also provides downside protection to the stock, he adds.
Higher TP for Singtel
Mittal has also kept his “buy” call on Singtel with a higher target price of $3.82 from $3.50 due to higher valuations from the telco’s associates, driven by Bharti.
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The analyst acknowledges that SingTel benefits from geographical diversification given its position as the number one integrated player Singapore while owning the number two mobile player in Australia. Singtel also holds “significant” stakes in its associates in India, Indonesia, the Philippines and Thailand. These associates contributed about 67% to Singtel’s total operating profit in FY2024 ended March 31.
In his report, the analyst points out that SingTel’s holding company (HoldCo) discount has narrowed to 32%, just below the five-year average of 34%. Mittal attributes this to an increase in the market value of its associates, improvements in core operating profit and increased exposure to data centres (DCs).
“This reduction is driven by growth in core operating profit from Singapore and Australia, which is supposed to generate the bulk of the free cash flow (FCF) to payout dividends,” Mittal adds.
Mittal notes that the Holdco discount was below 15% in FY2018, increasing as SingTel’s share price fell behind the market value growth of its associates.
Not accounting for divestments, Mittal expects core operating profit to increase by 8% in FY2025 forecasts, compared to -1% y-o-y in FY2024, driven by stronger growth in Optus, NCS and high growth visibility in data-centre business, which could narrow the Holdco discount.
Additionally, Mittal identifies divestments and potential consolidations in Singapore as potential catalysts. Mittal notes that 40% to 50% of divestment proceeds would be paid to value realisation dividends.
According to Mittal, “Singtel is a cheap proxy to Bharti with Singtel’s core operating profit resuming growth led by NCS, data-centre, and cost-cutting measures.”
Mittal notes that Bharti alone comprises 53% of SingTel’s sum-of-parts (SOP) valuation, and the higher target price is attributed to the 23%,26% and 31% rise in Bharti’s Airtel, AIS and Intouch’s share prices, respectively.
In aggregate, Mittal states that regional associates are worth $3.12 after a 20% HoldCo discount while the fair value of SingTel’s core business in Singapore and Australia is 70 cents per share.
To him, catalysts to Singtel’s earnings include divestments, where about 40% to 50% of proceeds would be paid as value realisation dividends. Consolidation among Singapore telecom players is also possible.
As at 4.44pm, units in Singtel are trading 7 cents higher or 2.21% up at $3.24 while units in StarHub are trading 1 cent higher or 0.83% up at $1.21.
