Singtel's sagging stock isn't an opportunity for investors but a sign of increasing risks

SINGAPORE Telecommunications (Singtel) could be the cheapest blue chip stock in the local market that nobody wants to own. And, it may remain that way until the company fortifies its balance sheet and makes fundamental changes to the way it is run.

This past week, Singtel released a "business update" for the quarter ended June 30 that was worse than the market expected. Operating revenue declined 13.9 per cent year-on-year to just over S$3.54 billion, while earnings before interest, tax, depreciation and amortisation (Ebitda) fell 24.2 per cent year-on-year to S$897 million.

Singtel attributed the weakness to lower equipment sales, reduced roaming and pre-paid mobile revenues in Singapore and Australia as well as delays in some information and communications technology projects under its enterprise division.

Pre-tax profit contributions from its regional associates increased 11.2 per cent year-on-year to S$373 million for the quarter. Singtel said this was due to reduced losses at Bharti Airtel in India, following tariff increases in December. Contributions from Telkomsel in Indonesia, AIS in Thailand and Globe in the Philippines declined as a result of Covid-19 lockdowns.

Singtel also took a net exceptional charge of S$364 million. This partly reflected Singtel's share of exceptional losses at Airtel of S$911 million, following additional provisions at Airtel for licence fees, spectrum usage and tax charges.

It also included a gain of S$550 million from the dilution of Singtel's effective shareholding in Airtel by 1.4 percentage points following Bharti Telecom's sale of 2.75 per cent stake in Airtel. As at June 30, Singtel held 49.4 per cent in Bharti Telecom and an effective 31.9 per cent in Airtel.

Not surprisingly, the market has reacted negatively to these weak financial numbers. Over the past week, Singtel's share price declined nearly 7 per cent, versus a more than 2 per cent dip in the Straits Times Index. Singtel closed on Friday at S$2.28.

Yet, analysts who cover Singtel have not gone cold on the stock. Instead, they are extolling the compelling value it seems to offer.

By their calculations, the associate stakes that Singtel holds in seven public-listed companies around the region - including locally listed Singapore Post and Netlink NBN Trust - have a combined current market value of about S$2.50 per Singtel share.

In other words, the market is ascribing negative value to Singtel's core operations in Singapore and Australia as well as to the investments the group has been making in various digital-oriented businesses.

It could just be a matter of time before the market comes to its senses and pushes Singtel significantly higher. DBS Research sees the stock hitting S$2.85 over the next 12 months. CGS-CIMB has a more aggressive price target of S$3.10.

Dividends in danger

However, investors who have tracked Singtel's financial numbers over the past decade might find it hard to get too excited about the stock.

While our lives have improved immeasurably with the advent of smartphones and ever faster mobile Internet speeds, Singtel has faced intense price competition and does not appear to have benefited at all in hard financial terms.

Its cumulative "underlying" earnings per share for FY2018 to FY2020 is almost 24 per cent lower than for FY2010 to FY2012. (Singtel has a March 30 financial year-end).

The group's cumulative Ebitda plus pre-tax profit contributions from its associates for FY2018 to FY2020 is almost 8 per cent lower than for FY2010 to FY2012.

Singtel's cumulative free cash flow for FY2018 to FY2020 is almost unchanged versus FY2010 to FY2012.

In fact, Singtel seems to be in worse financial shape than it was 10 years ago. For instance, it ended FY2020 with net debt of S$12.5 billion, almost twice the net debt of S$6.3 billion it had at the end of FY2010.

The ratio of Singtel's net debt to its Ebitda and pre-tax profit contributions from associates for FY2020 was two times, compared with only 0.9 times back in FY2010.

For FY2020, the ratio of Singtel's Ebitda plus pre-tax profit contributions from associates to its interest expenses was 13.8 times. That same ratio was 23.5 times back in FY2010, and as high as 29.2 times in FY2015.

Despite Singtel's worrying financial metrics, its stock has not performed too badly over the past decade. From end-2009 to end-2019, before the Covid-19 crisis started, shares in Singtel delivered a total return of 81.3 per cent. The Straits Times Index returned 25.4 per cent on the same basis.

However, a significant portion of that return came from Singtel's generous dividends, which are now being threatened by Covid-19 and the company's deteriorating financial position.

"Dividend payout is a key tool for Singtel to manage its balance sheet, in our view," said S&P Global Ratings, in a statement last week. The firm noted that Singtel obtained shareholder approval for a scrip dividend scheme in July.

More importantly, Singtel cut its final dividend for FY2020 to S$0.0545 per share, bringing its total ordinary dividend for the year down to S$0.1225. Singtel paid total ordinary dividends of S$0.175 per share for each of the preceding five financial years. It also paid a special dividend of S$0.03 per share for FY2018.

"We believe these corporate actions signal Singtel's intention to actively manage its discretionary cash outflow amid weak operating conditions," said S&P Global Ratings.

Asset sales, capital call?

So, what should Singtel do to restore investor confidence in its shares?

Logically, the company should take steps to fortify its balance sheet and address any doubt in the market about its ability to maintain its dividend while pursuing necessary 5G investments and continuing to support its regional associates through the Covid-19 crisis. This could be achieved through asset sales, or some form of capital raising.

It is perhaps also time for Singtel to review its strategy towards building up its digital businesses, as its efforts have so far not moved the needle in terms of group-wide profitability or market value.

This is a longstanding issue. In Singtel's FY2019 annual report, its then-chairman Simon Israel noted: "Your board is aware that the value of these investments is not being recognised in our share price, and management intends to unlock this value at the appropriate time."

In the wake of Covid-19, and the growing financial pressure it faces, Singtel should now look carefully at whether its digital businesses are really going to enjoy any lasting competitive advantage in their chosen fields.

Earlier this year, Singtel placed its video streaming business HOOQ under liquidation. In its FY2020 annual report, Singtel noted: "With the high cost of content and consumers' willingness to pay faltering amid an increasing array of choices, HOOQ was not able to grow sufficiently to provide sustainable returns nor cover content and operating costs."

Singtel also noted in the FY2020 annual report that another of its key digital businesses, advertising platform Amobee, faced "intense competition as a slew of new players entered the market" during the year. Singtel said in its recent quarterly business update that Amobee was hit by a reduction in advertising spending because of Covid-19.

To lift its depressed stock, Singtel needs to provide the market with a clearer sense of how it is creating value.