NetLink NBN Trust – Stable but higher rates start to nibble

 

 

The Positive

+ Of the S$7.5mn improvement in revenue, $4.7mn is from diversion. Diversion revenue comes from removing old fibre ducts to new locations due to the construction of new highways, MRT network and property development projects. Increased construction activity will speed up the completion of new homes and will aid in residential fibre connections. 

 

The Negative

­- Extra capex and interest expenses jump.  CAPEX rose 31% YoY to S$96.7mn. The extra spending is for a new Seletar Central Office (CO). CAPEX is expected to remain elevated this year. Capital commitments have almost tripled to S$138mn (FY22: S$52mn). The extra CAPEX required an increase in borrowing by around S$70mn, leading to higher interest expenses. As the country heads towards 10GBps broadband, more equipment will be required in the COs. To cater for the extra equipment, NetLink will need to expand power, cooling and space in the COs. The push toward Wifi 6e and 7, will be additional catalysts to drive up broadband demand.

NetLink NBN Trust – Yield not attractive enough

 

 

 

The Positive

+ Pick up in diversion. Bulk of the growth came from the almost tripling of diversion revenue to S$5.6mn.  The rise is due to heavy infrastructure projects -  from MRT to highways -  to which demand for diversion has jumped. Pre-pandemic, diversion revenue was trending at similar levels of S$5.4mn per quarter. Other segments that enjoyed revenue growth were NBAP (+38^ YoY) and central office (+13.5% YoY).

 

The Negative

­- Interest rates start to bite.  Net finance charge jumped almost 59% to S$3.6mn in 3Q23. Of the S$690mn of gross debt, 73.9% or S$510mn is fully hedged til 2026. The balance is an unhedged S$180mn floating rate loan at SORA plus a margin. Effective average interest rates have risen from 1.1% to 2.0%.

 

Outlook

The pressure points from higher interest rates remain. High-interest rates (and increased CAPEX for a new central office) will cap the growth in operating cash flows and the attractiveness of the current 6% dividend yield.

NetLink NBN Trust – Stable may not be enough

 

Results at a glance

Source: Company, PSR

 

The Positive

+ Rebound in diversion revenue. Diversion revenue picked up as construction activity returned especially for MRT and other infrastructure activity. Margin on diversion revenue is around 35% against the group EBITDA margin of 73%.

 

The Negative

­- Higher interest expenses and rates.  1H23 finance cost jumped 42% to S$7.6mn. The effective interest rate has risen to 1.9% (1H22: 1.1%). Around 74% of the loans have been hedged at a fixed interest rate, namely the 5-year term loan of S$510mn was hedged at 1% till May 2026.

 

Outlook

Cash-flows will remain stable with residential connection revenue rising around 1 to 2% p.a. Regulatory review may lower fibre rates due to the expanded base of connections after the previous review. Nevertheless continued CAPEX and a high WACC could keep any price changes minimal.

 

Our NEUTRAL recommendation is maintained with an lower TP of S$0.85 (prev. S$0.96)

Limited growth in DPU will be a challenge in a rising interest rate environment. Investors will look towards a higher dividend yield as risk-free rates rise. NetLink dividend yield spread over 10-year risk free has averaged 3.5% historically. It is now narrowed to 2.4%.

NetLink NBN Trust – Residential connections normalising

 

 

The Positive

+ Rebound in construction and installation activity. Residential connections are normalising post-pandemic. In the past two quarters, net connections were 11,842, triple the 3,946 a year ago. The rebound in construction and installation post-pandemic increased diversion revenue by S$1.8mn or 136% YoY.  Customers in diversion include HDB and LTA.

 

The Negative

­- Central office revenue sliding.  Major customer Singtel is renting less space as less telecommunication equipment is housed in Netlink’s seven central offices. Netlink will look to alternate users for their central office space.

 

Outlook

On the regulatory review, we expect a mild decline in the fibre price for residential connections. It is unlikely to impact dividend payout. Higher borrowings or lower capital expenditure can tide through any near-term shortfall, in our opinion.

 

 

Our NEUTRAL recommendation is maintained with an unchanged TP of S$0.96

The modest growth in DPU reduces the attractiveness of NetLink as an income-yielding investment. NetLink’s dividend spread over bond yields and other interest-yielding assets has not widened since interest rates started to climb this year.

NetLink NBN Trust – Stable dividends but limited growth

The Positive

+ Recovery in residential connections. During the pandemic, residential connections were around 15k in 2021. We have seen a significant recovery in connections, back to an annualised run-rate of 25k-26k. The lifting of COVID-19 restrictions is improving the construction of new residential homes.

 

The Negatives

­- Ducts and manholes see multi-quarter decline.  The weakest revenue segment has been the 3% reduction in duct and manhole revenues. Major customer Singtel will see less use of the ducts for their copper lines.  

 

Outlook

The upcoming regulatory review will determine the residential tariffs for the next five years. Factors considered will be WACC, size of the regulated asset base, future capital expenditure and the number of connections. Our model assumes no change in tariff. Nevertheless, lower tariffs may impact cash available for distribution. However, there are other levers to maintain near-term dividends such as higher borrowings or lower capital expenditure.

 

We maintain our NEUTRAL recommendation with an unchanged TP of S$0.96

We expect distribution per unit to be stable. The continuous rise in interest can taper the attractiveness of the distribution as earnings growth will be limited.  

NetLink NBN Trust – Higher interest rates become a headwind

 

The Positives

+ Pick up in connections. 3Q22 experienced a pick-up in residential and business connections. Residential connections during the quarter were up 7,243, the highest in five quarters and a 28% YoY jump. Non-residential, or business connections, similarly enjoyed an improvement in numbers. The additional 700 connections this quarter were the highest since 2Q19.

+ Plunge in net finance charges. 3Q22 finance charges dropped 46% to S$2.3mn. The effective interest rate has declined from 2.4% to 1.1%. NETLINK has hedged the interest rate on half its S$666mn gross debt. The remaining unhedged portion bears a SORA interest rate of 20-25 bps. The next upcoming debt due for renewal is a S$156mn revolving credit facility, due in March 2023.

 

The Negatives

- Diversion revenue declined. Diversion revenue was down 48% YoY to S$2.0mn in 3Q22. The capacity and availability of contractors are still impacted by the shortage of workers. Margins are low for diversion revenue.

 

Outlook

The regulatory review of fibre prices will be announced this year and will be effective 1 January 2023. We worry that prices may be under pressure due to lower interest rates compared with 2017 and the higher number of subscribers. However, the increase in the regulated asset base can minimize any downside to tariffs. Another lever to maintain dividends will be to raise borrowings or reduce capital expenditure.

 

We downgrade our ACCUMULATE recommendation to NEUTRAL with a lower TP of S$0.96

Rising interest rates are becoming a headwind for the share price through higher financing costs, lower valuations and a re-rating.

NetLink NBN Trust-Some growth returning

The Positives

+ Normalised EBITDA expanded 3% YoY. Excluding the lease receivable remeasurement loss of S$12mn and grants and rebates last year of S$5.4mn, EBITDA is 1H22 would have risen 3.1% YoY to S$138mn (1H21: S$134.3mn). EBITDA  growth came from the 38% revenue growth in diversion and co-location revenue to S$14mn. A rebound from last years circuit breaker disruption.

+ Lower interest expense. Finance cost was down 45% YoY to S$5.3mn. Borrowing cost has been lowered from 2.4% to 1.1% following the refinancing in June. Some of the hedges in the prior period has started to run off.

 

The Negatives

­- Residential connections are still soft. New residential connections in 1H22 were only 3,946. A steep drop from 9,915 in 1H21. Our forecast for FY22e is lowered from 25,000 to 10,000 new connections.

 

Outlook

FY22e is a recovery from the circuit breaker disruption. Installation revenue from NBAP and diversion work rebounded from a low base last year. There is still a lingering impact from the pandemic due to delay in home construction, impacting residential connections. The increase in capital expenditure will depress dividends in the near term, but will build up the regulated asset base and yield returns in the next regulatory review

 

 

Our ACCUMULATE recommendation maintained on unchanged TP of S$1.03

NetLink’s dividend is stable with support from monthly recurring connection revenue and capital expenditure flexibility.

 

NetLink NBN Trust – Fibre connections modestly weaker

 

The Positive

+ Non-residential connections highest in six quarters. Non-residential connections rose around 490  to 48.6k, the biggest increase in six quarters. The improvement came from higher take-up by small-medium enterprises. Non-residential is stable, around 8% of revenue.

 

The Negatives

­- Run-rate of residential connections below our model. We are expecting 25k new residential connections in FY22e. 1Q22 new connections were only 2.3k. We expect improvements in 2HFY22 as HDB construction gathers pace. The 25k net additions represented a 1.7% increase to 1.44mn.

 

- Ducts and manholes remained weak. Revenue from ducts and manholes declined 5% YoY to S$7mn. The weakness could persist as major customer SingTel (ST SP,ACCUMULATE, TP S$2.52) will have less use of these ducts for copper-wire installations.

 

Outlook

FY22e should be a stable year for earnings and cash flows, supported by a large installed base of fibre connections. A 5-year regulatory review of prices will take place next year. There is limited visibility at present but fibre price charges may be moderately lower due to a decline in WACC and a higher base of connections. Offsetting this would be NetLink’s larger regulatory base and lower capex. Both should keep FCF at around S$200mn to sustain dividends.

 

 

Maintain ACCUMULATE and TP of S$1.03

NetLink’s key attribute is stable dividend yields backed by monthly recurring revenue from more than 2mn fibre connections in homes and businesses.

NetLink NBN Trust – Steady as she goes

 

The Positive

+ Connections recovered from lockdown. Residential connections were 9,088 in 2Q21, after only 827 in 1Q21. Another positive was its addition of 470 non-residential connections, though still not sufficient to cover 1Q21’s loss of 681 connections.

 

The Negative

­- Ducts and manholes could deteriorate further. Revenue from this segment could remain weak as joint projects with its major telco customer have slowed down. This customer is building its own fibre projects and has become less reliant on NetLink.

 

Outlook

Operations are expected to be stable, supported by a gradual rise in residential connections. Following the migration of StarHub’s (STH SP, NEUTRAL, S$1.24) customers from cable to fibre in 2019, residential connections are now trending at 5,000 per quarter vs. 24,900 in FY20. This is consistent with expected annual household formations in Singapore. FCF of S$113mn generated in 1H21 can well cover the S$98.6mn in dividends payable, in our estimation.

 

Maintain ACCUMULATE and TP of S$1.03

Dividend yields remain attractive and sustainable. Minimal changes to our forecasts. For FY21e, we are still expecting a DPS of 5.08 cents. This implies a payout of S$198mn, which should be supported by FY21e FCF of S$204mn.

NetLink NBN Trust – Minor disruption but compensated

 

The Positives

+ Compensated for the loss in revenue. Netlink was compensated for the lockdown. EBITDA grew 3.4% YoY due to the contribution of S$2mn from JSS and another net $1mn property tax rebate. The grants will remain into the following quarters but at lower amounts.

 

The Negative

­- All activity reliant revenue suffered. Lockdown delayed activity in multiple business segments. Lack of workers meant reduced installation for residential and non-residential installations. A slowdown in property and infrastructure construction activity meant less diversion revenue.

 

Outlook

The weaker financials was due to the lockdown. The availability of workers is now back to normal capacity. We expect any loss in revenue this quarter to recover in the following months. Only diversion revenue (~4% FY19 revenue) could face a long delay. It is dependent on major construction projects which will require more time to restart.  Conversely, the pandemic has resulted in more activities to be conducted at homes. This will help to accelerate the adoption of fibre with households. Capex might be lower than last year as it is tied to installation activity.

 

Maintain ACCUMULATE with unchanged TP of S$1.03.

We find NetLink dividend yields attractive and sustainable. Recurrent revenues from the monthly subscription of residential connections provide a stable base of cash-flows to maintain dividends. Furthermore, regulated returns from capital expenditure will provide additional growth in future years.

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