Investors should reward, not penalise telcos that shift from yield to growth

MAINBOARD-LISTED telco StarHub has long been viewed as a yield stock, thanks to its generous dividend payouts in the past. But this may not be the best strategy for the company in the current environment, and the market ought to recognise that.

Between 2011 and 2017, the company paid out S$0.20 a share in dividends annually - giving the stock a yield of between 4.5 and 7.5 per cent in those years.

In the face of technological disruption and other headwinds, however, StarHub has not been able to afford such generous dividends for some time. And its valuation has declined as a result.

In an effort to regain its edge, the company announced in 2018 that it would begin cutting costs and improving operational efficiency. Investments were also made into its enterprise business segments. For instance, StarHub has bought data services company Strateq and ICT services provider HKBN JOS in Singapore and Malaysia in the past 3 years.

These initiatives have had a modest impact. Net profit for FY2021 rose 1 per cent year on year to S$81.4 million, without adjustments to account for the effects of the Jobs Support Scheme, while revenue remained flat at S$1.07 billion.

The company's FY2021 dividend stood at S$0.064 - which was higher than the S$0.05 it paid out a year earlier. This gives the company a dividend yield of 5 per cent, based on its current share price of S$1.27.

But dividends are set to fall in the coming quarters as StarHub embarks on the next stage of its transformation plan. As part of its Dare+ initiative announced in November last year, the company will look to drive an additional S$220 million in gross profit cumulatively between FY2022 and FY2026 on top of additional cost savings.

On its earnings call on Feb 11, the company committed to a higher capital expenditure of 12 to 15 per cent over the next 2 years - higher than the 7 to 9 per cent expected without these initiatives.

This would reduce its margin of earnings before interest, taxes, depreciation and amortisation (Ebitda) to at least 20 per cent this year, versus about 31 per cent in 2021. Recovery is expected only in 2023.

When markets opened a day after, however, both analysts and investors appeared spooked. StarHub shares fell 3.8 per cent to S$1.28, S$0.10 above the company's 52-week low of S$1.18.

According to Bloomberg data, there were 8 "buy" calls and 9 "hold" calls on StarHub a day before its earnings call. As of Feb 18, there were 4 "buy" calls, 12 "hold" calls and 1 "sell" call.

Citi analyst Arthur Pineda downgraded StarHub's target price from S$2.00 to S$1.16 and dropped his call on the company from "buy" to "sell". In cutting the company's net profit estimates for FY2022 and FY2023, he concluded that the company would likely pay out its dividend floor of S$0.05 this year, causing yields to fall to a "non-compelling" 3.8 per cent for FY2022 before recovering to 5.1 per cent in FY2023. He also noted that in a rising interest rate environment, the company's yields look even less appealing.

Similarly, DBS' Sachin Mittal cut the company's target price to S$1.31 from S$1.60 and held his "hold" call on the company due to a cut in the company's net profit estimates.

Growth vs yield

The analyst recommendations align with common wisdom that telcos are simply yield stocks: with limited scope for growth, the best way for them to deploy their cash is to return it to shareholders.

Indeed, StarHub operates in a very saturated Singapore market. Mobile penetration rates stood at 149.9 per cent as of May last year. Residential wired broadband penetration rates hovered at between 91.8 and 93.5 per cent for the first six months of 2021. And pay-TV, once a domestic game, is now an international playing field.

But it may be time for telcos to shed the conservative mindset.

Although the telcos are used to competition, the difference today is that not all of their competitors are competing with profitability as an end-goal. And so a telco that is not innovating fast and branching into new markets may find itself, eventually, without much of a business at all.

StarHub is certainly trying new things. For instance, it aims to build a new suite of Internet-based solutions by bundling other applications, such as Disney+ and Nvidia's GeForce Now game streaming, in order to drive average revenues per user.

To improve customers' access to these services, StarHub is also adapting some of the lessons learnt from the launch of its own mobile virtual network operator to build a new "super-app". And on the back end, the company has said that it will work to shift its current legacy systems into the cloud for further efficiency gains.

Given the explosion in Internet-based services online, there is room for StarHub to grow its business in this space - whether alone or through collaboration with other online platforms to build an ecosystem.

We do not need to look far for an example of how this could be done. Globe Telecom in the Philippines trades at 23 times its forward earnings, ahead of StarHub's 15 times, due to its investment in fintech Mynt, which operates the popular GCash mobile payments app.

In building out its ecosystem, Globe has looked for problems that the telco could be in a good position to solve. For instance, telemedicine was a natural fit since customers will be communicating over the network anyway.

Globe's executive director, president and chief executive Ernest Cu last year told The Business Times: "We always get excited about social media as a platform, or search as a platform, right? But why is no one excited about telcos as a platform when it has the reach, the capital and the data about consumers with which to start a business?"

New possibilities

The Singapore government has also shown an awareness of the immense potential of Internet and broadband equipment, even if the use cases may not be apparent yet.

Finance Minister Lawrence Wong said during his Budget speech last Friday (Feb 18) that an additional S$200 million will be set aside over the next few years to build additional capabilities in businesses and workers. The government will also look at increasing broadband access speeds by about 10 times over the next few years.

"The use cases for such high speeds are still nascent, but there are many new possibilities for augmented and virtual reality tools, limited only by our imagination," Wong added.

In an increasingly digital world, investors ought to push telcos to reimagine their roles in this space to gain better valuations - even if it may require some upfront capex costs and result in lower dividends.

Telcos, meanwhile, should articulate coherent stories that tie their initiatives together in order to win investors over to support their growth strategy.

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