Citi Research analysts Luis Hilado and Arthur Pineda have upgraded their call for NetLink to ‘buy’ from ‘neutral’, with a target price (TP) of 91 cents.
According to the analysts, NetLink’s negatives are likely priced in, and the stock’s sharp decline appears to have more than fully factored in interconnect rate cuts in 4QFY2023 ending March 2023 while discounting consensus estimates.
Their TP of 91 cents is derived by a free cash flow to firm (FCFF) based valuation methodology, with a risk-free rate of 2.5%, an equity premium of 6.5%, beta of 0.5, cost of debt of 3.5% and a target debt to assets ratio of 20% to arrive at a weighted average cost of capital (WACC) of 5.2%.
“For our terminal value calculations, we have assumed a long-term growth rate of zero. Our model factors in pricing cuts with every five-year return on asset base review cycle. Our model assumes an 8% cut in residential and non-residential fibre connection pricing for the next regulatory pricing review in FY2023,” say the analysts.
“Our current FY2024 revenue and profit outlooks remain below consensus estimates, which we believe are assuming flat interconnect rates. The market, however, has discounted consensus earnings, in our view, taking the stock down 17% year-to-date (ytd),” they add.
Hilado and Pineda believe that at their below-consensus estimates, the stock offers value against its historical dividend yield, PE and EV/ebitda means. They have maintained their forecasts for the upcoming 1HFY2023 results due on Nov 2.
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“We believe the stock offers value at current levels at a more than 6% sustainable yield even on our more bearish than consensus earnings outlook,” say the analysts, explaining their upgraded call for the stock.
They note that rising interest rates remain a risk to the share price performance, as the yield gap between NetLink’s dividend yield and 10-year Singapore rates is below the mean.
Other key downside risks include a larger interconnect rate deduction than anticipated, the continuing negative economic environment and poor consumer sentiment leading to broadband service disconnections.
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The way the Citi analysts see it however, there are greater upside risks to their call.
With a rate decision by regulator Infocomm Media Development Authority (IMDA) being eyed closer to the new rate regime date in January 2023 rather than seven months earlier, they say that NetLink management has the opportunity to present a case that the current rising rate environment justifies a steady, if not higher, rate of return — unlike the prior process in 2018 and 2019.
“This would put our base-case assumption of an 8% rate cut at risk. As our bull/bear scenario highlights, a rate status quo throughout the forecast period could add 18 cents, or around 20%, per share to our TP,” say the analysts.
As at 10.43am, units in NetLink traded flat at 86 cents.
