DBS Group Research’s Sachin Mittal has upgraded his call on Netlink NBN Trust to “buy” with a higher target price of $1.05, up from the previous figure of $1.02.
According to Mittal in his March 9 note, the stock currently has “an attractive 5.4% yield for its low-risk profile.”
“With Singapore’s risk-free rate rising to 1.9%, NetLink’s regulatory rate is likely to be stable,” writes the analyst.
“When NetLink was listed four years ago, [its] risk-free rate was 2.1%. We project a risk-free rate of 2.1%/2.2% by the end of FY2022/FY2023,” he adds.
A higher risk-free rate means that there is a lower risk of a drop in the regulatory rate for the next review period over January 2023 to December 2027, notes the analyst.
He is referring to the outcome of Netlink’s negotiations with the Infocomm Media Development Authority (IMDA) on the interconnection offer (ICO) pricing for the next review period (2023-2027).
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The ICO pricing governs the prices set for some of Netlink’s services, such as those related to residential connections, non-residential connections, NBAP and segment fibre connections, as well as ducts and manholes service revenue.
Mittal thinks that NetLink’s distribution yield spread is likely to narrow to 300 basis points (bps) to reflect its lower risk profile.
At the current 10-year bond yield of about 1.9%, NetLink is trading at a 350 bps spread vs. its own historical average of 310 bps.
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As such, he thinks that it has “big room” to gear up to meet any unforeseen circumstances.
Furthermore, high inflation should not eat into distributions, as inflationary pressures on capex and opex are taken into consideration when regulatory return is determined under the Regulated Asset Base (RAB) model.
However, he does acknowledge that he is “conservative” in his valuation of Netlink, adding, “we expect annual capex to hover between $55 million to $60 million in the long term and any potential rise in capex (due to inflation) or acquisitions could be a positive surprise, not factored into our valuation.”
Despite the upgrade, Mittal warns that investors should look out for a sharp rise in risk-free rates, which could prove as a downside risk to the counter.
He says if the risk-free rate rises to 2.6-2.7% vs his prediction of 2.1%, then Netlink might trade at a 300-310bps spread at a 5.7% yield, leading to a “bear case target price” of 90 cents.
As at 3.30pm, shares of Netlink were trading at 97 cents, with a price to book ratio of 1.4 and dividend yield of 5.3%.
