Singtel: ROIC and segmental expectations for FY24F and beyond
- Singtel’s return on invested capital (ROIC) to exceed its weighted cost of capital (WACC) in FY24F after a gap of 4 years; Indosat rallied last year after ROIC exceeded WACC
- We expect a 10% y-o-y core operating profit (EBIT) growth in 2H24F led by an absence of Trustwave losses and cost-cuts at Optus; core EBIT has a 84% correlation with the share price
- BUY with TP of S$3.39 for >40% upside potential and 5.5% yield; potential catalysts would be ROIC exceeding WACC, higher dividends and divestments
Singtel is implementing a two-pronged approach to boost operating profits and ROIC. ROIC is generally difficult to improve unless there is a cut in opex and capex. The aggressive cost-cutting of S$200m each year over FY23-26F is one key driver. Potentially, double-digit growth in operating profit at NCS & the data centre business (20% of group core EBIT in 1H24) is another key driver.
We project Singtel would record group core EBIT of S$584m in 2H24F, up 10% y-o-y, flattish h-o-h, due to the following reasons:
- Optus is to benefit from tariff hikes and backend-loaded cost-savings, which would potentially offset the network outage impact. On 8 November 2023, Optus faced a nationwide outage that would have some adverse impact on its revenue in 2H24F. Although, the impact won’t be big and is likely to be short-lived, as per our channel checks. Electricity costs in Australia rose by 46% in 1H24, which impacted Optus’s EBIT in 1H24, leading to aggressive tariff hikes by Optus in mid-2023. Backend-loaded cost-savings at Optus after it right-sized its enterprise business unit should help it achieve sequentially stable EBIT in 2HFY24F, in our estimates. Out of the S$200m cost-savings targeted by the group for FY24F, we expect S$120-130m to be realised in 2H24F, largely at Optus.
- NCS growth to continue, with most of the contract re-repricing done and wage inflation on a decline. Singtel’s NCS EBIT declined by 35% in FY23, despite a 16% rise in revenue due to higher wage inflation. However, NCS has been faring well from 1H24 onwards, with 1H24 EBIT rising by 72% y-o-y on 9% revenue growth. NCS contributed 16% to the group’s core EBIT in 1H24. Ongoing cost-savings at NCS should support double-digit growth, in our view.
- Trustwave losses to be absent from 3Q24F onwards. Trustwave recorded an EBIT loss of S$27m in 2Q24 and S$56m in 1H24. As at 2Q24, Trustwave was classified as a “subsidiary held for sale”, and thus will not contribute any losses to group EBIT from 3Q24F onwards. Following the completion of Trustwave’s divestment, the estimated yearly loss contribution of S$120-130m will also not exist from FY25F onwards.
ROIC is a critical factor for the share price especially when ROIC falls below or rises above WACC. Singtel’s share price has demonstrated a positive correlation of 87% with its ROIC over FY18-FY23 (6-years), implying when the ROIC rises, the share price inches up. Our ROIC calculations also include the Optus’ goodwill on Singtel’s balance sheet compared to Singtel’s ROIC calculations which exclude the Optus’ goodwill. Based on the chart above, the ROIC falling from 7.7% in FY19 to 6.6% in FY20, below Singtel’s estimated WACC, led to a decline of 32% in Singtel’s share price. Similarly, when ROIC fell to 5.2% in FY21, the share price fell by 10% to S$2.21 during early May 2021 to early July 2021. Weaknesses in its core business coupled with reduced contribution from associates were the reason. ROIC falling below the WACC lead to sharp correction in the stock price. The WACC of a company often acts as a breaking point for the ROIC resulting in a significant movement of the stock price.
Singtel is doubling down on its IT services arm, NCS, as a key driver of future growth. Management sees the company's focus on digitalisation projects and overseas expansion as key to achieving its ambitious revenue target of S$5bn by FY26, up from S$2.7bn in FY23. NCS's international footprint has been steadily expanding, with overseas revenue now accounting for 15% of the total, a significant jump from 5% in FY19. Similarly, the enterprise segment has grown from contributing 25% of revenue in FY19 to 33% in FY23, highlighting the increasing demand for NCS's digital solutions. While rising wage costs in FY23 posed a challenge, management remains confident in NCS's ability to deliver EBITDA growth with declining wage inflation. However, for the remainder of FY24F, revenue growth is likely to be partially offset by some margin compression in the enterprise segment due to the continued high wages.
Singtel is aiming to grow its data centre business, planning to more than double its capacity within the next three years. This expansion will see Singtel’s current capacity of 60MW soar to 155MW, solidifying its position as a major player in the region's booming data centre market. However, Singtel's expansion extends beyond Singapore. Through strategic partnerships with AIS/Gulf in Thailand and Telkom in Indonesia, the company plans to add a further 37MW, respectively, bringing the combined total capacity to 155MW within three years. The company is also exploring opportunities in Vietnam and Malaysia through targeted partnerships. Singtel's data centre strategy is built on long-term customer contracts, typically lasting 10 years. This creates inherent customer "stickiness", ensuring a steady stream of recurring revenue. To capitalize on this growth, Singtel has incorporated annual contractual price escalation and uplift mechanisms into its contracts, guaranteeing sustainable revenue growth. Also, most utility costs are passed through to customers, effectively protecting Singtel's margins and ensuring profitability. This two-pronged approach – locking in long-term contracts and ensuring revenue growth through pricing mechanisms – positions Singtel for strong sustained growth in the years to come.
Merger between Telstra being called off is likely to benefit Optus. In early 2022, Telstra and TPG proposed a network-sharing agreement in regional Australia. However, the Australian Competition and Consumer Commission (ACCC) rejected the initial application in December 2022 on concerns about reduced competition and potential price increases for consumers. Telstra and TPG appealed the decision to the Australian Competition Tribunal, but the Tribunal upheld the ACCC's decision in June 2023. If the deal went through, TPG’s 4G coverage of Australia would have increased from 96% to about 98.8%. Meanwhile, Telstra could have benefitted from TPG’s 4G and 5G spectrums. Optus, the main competitor to both Telstra and TPG, saw it as a massive competition concern, leading to higher prices, lower investment, less consumer choice, and less infrastructure resilience. Telstra wanted access to TPG’s spectrum for network capacity, which is not possible now. It makes sense for Optus and TPG to share their networks to improve 4G & 5G coverage, in our view.
| FY Mar | 4Q2019 | 3Q2020 | 4Q2020 | % chg yoy | % chg qoq |
|---|---|---|---|---|---|
| Revenue | 4,342 | 4,378 | 3,899 | (10.2) | (10.9) |
| Cost of Goods Sold | (3,238) | (3,255) | (2,906) | (10.3) | (10.7) |
| Gross Profit | 1,104 | 1,123 | 993 | (10.1) | (11.6) |
| Other Oper. (Exp)/Inc | (498) | (593) | (622) | 24.9 | 4.9 |
| Operating Profit | 606 | 530 | 371 | (38.8) | (30.0) |
| Other Non Opg (Exp)/Inc | 0.00 | 0.00 | 0.00 | - | - |
| Associates & JV Inc | 419 | 420 | 521 | 24.3 | 24.0 |
| Net Interest (Exp)/Inc | (93.0) | (156) | (93.0) | 0.0 | 40.4 |
| Exceptional Gain/(Loss) | 76.0 | 76.0 | (19.0) | nm | nm |
| Pre-tax Profit | 1,008 | 870 | 780 | (22.6) | (10.3) |
| Tax | (241) | (250) | (209) | (13.3) | (16.4) |
| Minority Interest | 6.00 | 7.00 | 3.00 | (50.0) | (57.1) |
| Net Profit | 773 | 627 | 574 | (25.7) | (8.5) |
| Net profit bef Except. | 697 | 551 | 593 | (14.9) | 7.6 |
| EBITDA | 1,025 | 950 | 892 | (13.0) | (6.1) |
| Margins | |||||
| Gross Margins (%) | 25.4 | 25.7 | 25.5 | ||
| Opg Profit Margins (%) | 14.0 | 12.1 | 9.5 | ||
| Net Profit Margins (%) | 17.8 | 14.3 | 14.7 |
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