NetLink NBN Trust – Higher rates start to bite

 

Results at a glance

 

 

 

 

 

 

 

The Positive

+ Rebound in residential connection. 2H24 net adds recovered 15,334 connections after the weak 1H24 of 6,392. Connection in FY24 was 21,726 and within our expectations of 22,000 per year or household formations per year. Connections are volatile on a quarterly basis due to the timing in the availability of sites.

 

The Negative

­- Finance cost rose 19% YoY.  Higher effective interest rate of 2.75% push interest expenses up by 19% to S$10.8mn. Netlink has raised its hedged debt to 78% in FY24 (FY23: 69%). We believe this resulted in some hedging gains, especially in 3Q24. With the elevated capex for the new central office in Seletar, interest expenses will remain a drag on DPU.

NetLink NBN Trust – Stable as usual

 

 

The Positive

+ Higher distribution. Interim distribution rose 1.1% YoY 2.65 cents. This is modestly higher than our expectations of unchanged distribution for the year. NetLink is paying out S$103mn in distributions from free-cash flow of around S$80mn.  The balance is topped up from cash held in reserves.

 

The Negatives

­- Another weak quarter of residential connections.  Residential connections increased by only 2,369 in 2Q24, the weakest in eight quarters. We believe delays or renovation periods before moving into the new homes drove the sluggishness.

 

- Finance cost rose 30% YoY.  The unhedged portion of S$735mn gross debt continued to be a drag on cash-flows. Net finance cost rose 30% to S$9.2mn. Assuming the current interest rate hedged loan of S$510mn is repriced upwards by 300 bps, the distribution could be negatively impacted by around 7.5%.

NetLink NBN Trust – Waiting for tariff review

 

The Positive

+ Opportunity in higher broadband bandwidth. As 10GBps broadband speeds become more available over the next few years, there will be more demand from telcos at Netlink central offices. Demand is for larger space, more cooling and increased power supply in the central office. The timeline to roll out more 10GBps will ultimately depend on customer end demand and use cases.

 

The Negatives

­- Slower than expected residential connections.  Residential connections increased by 4,023 in 1Q24, the slowest in four quarters. The weakness is caused by delays or time taken to renovate and move into the vacant units.

 

- Continued rise in interest expenses.  Although the borrowings at a fixed rate is stable at 69.4%, the effective average interest rate in 1Q24 rose by 0.8% points YoY to 2.6%, driving interest expense up.

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.

 

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