Company Analysis: Singtel (Ticker: Z74.SI)

It’s been on my mind for quite some time now to perform a financial analysis of a company, using available financial data and valuation models. I’ve always been looking at charts, aka technical analysis, to shape my investment views and it’s probably time I started analysing companies based on more than just price movements.

So…What better way to attempt some fundamental analysis than on the second-largest listed company in Singapore, Singtel? Attempting analysis on a company of this size may be biting off more than I can chew, but I shall give it a try anyway.

Singtel is Singapore’s largest telecommunications service provider, with a market capitalisation in excess of $60 billion, more than 10 times larger than its next biggest competitor, Starhub, at $6 billion. Actually, most Singaporean readers will be sufficient knowledgeable about this company and its two competitors and therefore I shall not bore you with further elaboration. 

However, not everybody is aware that Singtel is actually a well-diversified telecom company, owning 100% of Optus, the second-largest telecom company in Australia, as well as having stakes in various telecom companies in the region, in places such as Indonesia, Thailand, The Philippines and India. In fact, Singtel derives more than 70% of its earnings outside of Singapore.

Recently, there have been concerns that a fourth telco provider in Singapore could disrupt the oligopoly enjoyed by the current three telcos in Singapore, sapping their market share which results in lower revenues. Of the three, Singtel is widely-agreed to be the least affected, having diversified itself sufficiently. Therefore, should a fourth telco emerge, I do not expect Singtel’s revenues to suffer drastically.

But before I dive straight into the boring figures, let me pull up a chart of Singtel and perform our favourite technical analysis.

Examining the year-to-date (YTD) chart of Singtel, we see that the stock has been on an uptrend for much of the year. In late June, prices managed to push above strong resistance at $4, which it retested in late July/early August, confirming the former resistance has turned into support. 

However, following news of 3 telecom operators submitting their bids to become the fourth telco in Singapore in early September, the stock tanked and plummeted below the important $4 level. It also closed below the trendline connecting the lows from the previous uptrend. 

The next level of support lies at $3.75, and below that, around $3.65. However, with both the Relative Strength Index and StochasticOscillator currently registering drastically oversold conditions, a drop downward to test those levels looks unlikely without further catalysts. 

In the short term, Singtel looks very oversold and I suspect bargain hunters and traders alike would take this opportunity to buy in, pushing prices higher next week. A rebound to the critical $4 level looks likely in the near term. Caution is advised for those trading for the longer term as the 20 day SMA looks to be crossing below the 50 day SMA -- a bearish signal. With more impending news regarding the fourth telco, expect more volatility in the weeks ahead.

Now, it’s time for the numbers! I shall start off by listing some important figures and valuation metrics, conveniently compiled into a table for you.

	2016	2015	2014	2013	2012	2011
Revenue*	16961	17223	16848	18183	18825	18071
EBITDA*	5013	5091	5155	5200	5219	5119
Net Profit*	3871	3782	3652	3508	3989	3825
EPS**	24.29	23.73	22.92	22.02	25.04	24.02
DPS**	17.5	17.5	16.8	16.8	15.8	15.8
NAV/share**	156.9	155.2	149.8	150.4	147.1	152.8
ROE	15.19%	15.6%	15.3%	14.8%	16.7%	16.0%
ROA	4.19%	9.3%	9.2%	8.7%	10.0%	9.9%
FCF*	2718	3549	3391	3759	3462	4038

*Figures in millions of SGD

**Figures in Singapore Cents

For those of you unfamiliar with the acronyms/terms in the table, I’ve provided links to their explanations. Of course, there are plenty more valuation metrics than the ones I’ve listed, but I’ve decided to focus on the more important ones, and the ones I’ve learned to use. 

Just looking at the figures alone, before performing any calculations, we can see than Singtel is a stable company that generates consistent results year after year. Revenue and net profit do not vary much, the company generates strong free cash flow year after year, and dividends are increasing steadily. This is attributed to its size and dominance in the marketplace. 

Being a utility stock, it lives up to the stereotype of generous dividends (Singtel aims for 70% payout ratio; It’s dividend yield is around 4%). However, its 500-day rolling beta, a measure of volatility, is currently 1.04 according to ShareInvestor, which does not fit that stereotype (utility stocks are generally low-beta). This could be due to Singtel being the largest constituent of the Straits Times Index, hence movements in Singtel’s price affect movements in the index to a greater extent than other constituents. 

Before I sidetrack too much, let’s get down to the business of valuation. I shall attempt to value Singtel using 2 different models: the Dividend Discount Model and Free Cash Flow to the Firm. It’s my first time performing analysis of such kind and so do pardon and correct me if I’ve made any mistakes!

(For those who are more averse to math, feel free to skip the calculations and jump to the final number, which I will provide at the end of each section)

The Dividend Discount Model:

Also known as the Gordon Model, after the professor who invented it, the core concept here is that the value of the firm, and therefore its stock, should be the present value of all its future dividend payments to the investor. Therefore, this involves discounting those future cash flows to the investor to their present value today.

So, to find out the fair value of Singtel stock based on this model, we simply plug in the relevant numbers. Looking at dividend per share figure going back to 2011 (refer to table above), we see that Singtel is, on average, able to grow its dividends at approximately 5% every two years, which I shall simplify to 2.5% per annum. We now have our figure for g! No sweat so far huh?

The problem lies in finding the appropriate discount/interest rate to apply. One of the books on value investing I’ve read advises using the Capital Asset Pricing Model (CAPM) to derive this rate:

r = r_rf + β (r_m – r_rf)

where r = appropriate interest/discount rate

r_rf = risk-free rate, such as those on Singapore government bonds

r_m = return on the market, or the returns of a broad based index

β = beta of the security

Because financial analysts always cannot agree on exactly what numbers to use for the inputs, I’m going to use my own set of numbers, what I feel should be the value for each term in the equation. For the risk-free rate, I’ll use 1.8%, the yield on 10-year Singapore Government Bonds. For return on the market, I’ll use 8%, the approximate return on the StraitsTimes Index over the past 10 years, dividends reinvested. The beta of Singtel is known, at 1.04.

Plonking all these numbers into the equation generates a discount rate of 8.2%. Phew!

Applying the Dividend Discount Model, we arrive at a value of $3.15! That means, based on this model, the fair value one should pay for a share of Singtel would be $3.15. At $3.87 as of the close on Friday, 2 September, the current market price implies that Singtel is trading at a 23% premium to the modelled price. For value investors, there is NO margin of safety, and therefore Singtel does not make a sound investment at this price.

Free Cash Flow to the Firm:

This one is much more tricky, and I don’t feel as confident in its execution, but I’ll give it a go anyway. WARNING: Very long calculations ahead! If you feel allergic to them please skip to the bottom of the section where I’ll provide the final number, I promise!

First, if you’re not familiar with the concept of Free Cash Flow, here’s a quick introduction to it. Since Singtel provides free cash flow information on their investor relations webpage, I’ll simply use their numbers. If not, I’ll proceed to define Free Cash Flow to the Firm (FCFF), since it’s not a standardised accounting formula.

FCFF = Cash Flows from Operations + Interest Expense (1 – Tax Rate) – Capital Expenditures

Therefore, the market value of the firm using the FCFF model is:

However, to use the simplified equation, one must first derive/estimate the FCFF for the following year. The formula takes over by extrapolating from there on.

Oh gosh, this part requires the most effort to piece together. The numbers required for calculation are scattered everywhere! So dear reader please appreciate what I’m doing for your ease of reading. Be glad you don’t have to source for these numbers pouring through the 235 page annual report!

We see that Singtel has a total of $9095 million in outstanding issued bonds, with a weighted average effective interest rate of 3.8% for fixed rate bonds, and 1.7% for floating rate bonds. Gah, for simplicity sake I’m going to assume the average effective interest rate for ALL bonds outstanding is 3%. For bank borrowings, the figure is 2.3% for $1267 million in debt. Total debt outstanding is $10362 million. 

To minimise headaches later on, I’m going to calculate the debt part of the WACC equation first:

For bonds, after-tax cost of debt, k_d

= Before –tax cost of debt x (1 – Tax Rate)

= 3% x (1 – 17%)

= 2.5%

For bank loans, k_d = 1.9%

Therefore,

Which works out to 0.003, or 0.3%! WHAT! After all that hard work with the calculations, just to arrive at this insignificant percentage!

For the cost of equity, K_e , the formula is the same as the risk free rate, which works out to 8.2%,  as we calculated earlier on. By now, I think even the math boffins would have given up working the equations and hence I’ll just plug these numbers into the equation off-screen…

…arriving at a WACC of 7.3%!

Now for the final step! Scanning the FCF values from the table above, we conclude that it has been fluctuating in a range, between 3.4 to 4 billion. To estimate the value of g required in the FCFF equation is going to be tricky. 

I shall assume a very pessimistic scenario of FCFF growing at just 2% per annum. For the estimated FCFF for the following year, I shall use $3000 million, again pessimistic estimates given rougher economic conditions expected. (Note: Singtel doesn’t’ generate interest expenses but instead is more profitable after interest!)

Plug that into equation and we arrive at a firm value of $56.6 billion. With a current market cap of $61.7 billion, this implies that Singtel shares are about 9% overvalued. Again, there is no margin of safety.

Conclusion:

Singtel, trading at prices above the modelled values, provides no margin of safety for value investors and therefore is not an ideal pick for a value investing candidate. However, being a stable and consistent performer as a utility stock, it provides shareholders with solid dividend payouts and a slow share price appreciation over the years. These factors probably explain why it trades at a premium and why many analysts still have a “Buy” call on Singtel despite the stock being seemingly overvalued.

Would I make an investment in Singtel? Yes, but if only at the right price (I’m hoping for the low end of $3, if that ever comes). A solid dividend provider, it can form the bedrock of any yield/passive income portfolio.