The Unloved: M1 | Company Analysis: M1 (SGX: B2F.SI)

2016 has been a tough year for M1. Its stock price is down more than 20% year-to-date, quarterly revenues and profits have been falling, and dismal news of a potential fourth telco company in Singapore have put further pressure on the company and its stock.

Investor confidence in M1 has taken a hit, triggering a wave of downgrades from brokers and analysts alike. Clearly, it has fallen out of favour with market players (rumours circulate about foreign funds dumping the stock). In the face of such bleak circumstances, could there be a case for investing in M1, in light of its low stock price and depressed valuations? Could a contrarian view on M1 be justified?

M1: A Brief Introduction

Beginning its commercial services in 1997, and making its debut on SGX in 2002, M1 is the smallest of Singapore’s 3 telecom operators, with a current market capitalization value of $1.92 Billion. Unlike its two larger rivals, SingTel and Starhub, all of its business is locally based and thus all of its revenue is derived from Singapore alone. 

With the threat of a potential fourth telecom operator entering the market, following a series of news reports in 2016, M1 has drawn the greatest scrutiny among the 3 telcos, as its lack of geographical diversification could affect future revenues drastically.

A Glance at the Past

 

	2011	2012	2013	2014	2015
Revenue	1,064.9	1,076.8	1,007.9	1,076.3	1,157.2
EBITDA	310.4	299.9	312.3	335.5	341.8
Net Profit	164.1	146.5	160.2	175.8	178.5
Free Cash Flow	161.3	152.3	176.0	93.1	105.7
Dividends paid	161.3	132.2	136.3	196.9	177.0
Cash and cash equivalents	11.84	11.61	54.45	22.78	9.97

*All figures in Millions of SGD

A glance at the financials of M1 over the past five fiscal years and we understand the concerns of investors immediately. Revenue growth is lackluster, and so can be said for EBITDA and net profit, both of which have barely grown over the past 5 years.

 Revenue shows fluctuation between 2011 and 2014, but seems to have improved in 2015. Although both EBITDA and net profit may seem to be slowly increasing over the years, the fact that it is not matched by a similarly sloped uptrend in revenue seems to suggest most of the increase is attributed to cost savings and lower expenditures, rather than actual business growth. 

Despite a growing customer base, average revenue per user (ARPU) has been falling as of late, in part due to increased competition in data price plans. Therefore, while M1 has become somewhat more profitable, the overall size of its business seems to expand at a much slower pace. 

Of greater concern is the persistently high dividend payout with respect to free cash flow. M1 pledges to distribute at least 80% of its annual net profit as dividends, explaining the generous annual dividend yields of around 6% (currently the dividend yield is closer to 7.5%). However, comparing free cash flow and dividends paid shows that such generous payouts are not always backed by strong cash flow. 

In 2014 and 2015, dividend payouts exceeded free cash flow generation – a red flag when considering the sustainability of dividend payouts. It also seems to suggest that the company has been using borrowings to finance its dividends. This has caused the company’s cash reserves to dwindle over the years. 

Low cash reserves translate into less money to fund expansion or purchases of equipment, or even cash to pay down short term debt and interest on debts of longer maturities. This puts strain on the company’s financial position as it may have to resort to more borrowing, and may threaten its financial health in the long run. 

However, a closer look at recent financial statements is required to understand the circumstances of M1 in fiscal year 2016. We shall examine the three quarterly reports so far, and compare them with those from one year ago.

	1Q2016	1Q2015	2Q2016	2Q2015	3Q2016	3Q2015
Revenue	256.6	294.8	240.4	276.8	249.1	277.6
Net Profit	42.5	45.7	41.0	44.3	34.4	44.9
Free Cash Flow	64.1	33.6	50.3	31.1	7.0	51.6
Dividends Paid	-	-	77.2	111.4	65.1	65.6
Cash and Cash Equivalents	11.6	17.8	8.2	33.0	9.7	26.1
Net Quarterly Borrowings	(42.3)	(48.2)	23.5	90.4	66.3	6.9

*All figures in Millions of SGD

As expected, every single quarter in 2016 records a decline in both revenue and net profit, when compared to respective quarters in 2015. This has been troubling investors as of late, and is the driver behind its falling stock price.

Looking at the latest 3Q2016 quarterly report, M1’s cash has deteriorated to a mere $9.7 million. We see that M1 has made net borrowings of $23.5 million in 2Q16 and $66.3 million in 3Q16. Adding these figures to the free cash flow generated for each quarter respectively gives a figure rather close to the amount of dividends paid. It leads one to suspect that the dividend payouts are partially financed by debt – the company is borrowing money to sustain its high dividend payouts, a.k.a. financial engineering.

 

To research the debt load of M1, I looked up its balance sheets since 2011 and unveiled a startling set of figures – current liabilities have always exceeded current assets in every year since 2011, with the exception of 2013. 

Fiscal Year	2011	2012	2013	2014	2015
Current Assets	260.6	246.2	249.1	229.5	260.5
Current Liabilities	310.7	524.4	234.8	274.5	561.8
Net Current Assets/(Liabilities)	(50.1)	(278.2)	14.3	(48.6)	(301.3)

*All figures in millions of SGD

Since so little profit is retained as so much of it is paid out as dividends, the company is heavily reliant on borrowings to fund its operations, expansion and dividend payouts. The debts are refinanced once due, at a manageable interest rate, such that the quarterly profits are more than sufficient to finance interest on the loans (which explains its times interest cover ratio of more than 80). This business model could work in stable expansionary times, where the profits are more than sufficient to cover the interest payments, and loans can be refinanced at manageable rates. 

However, in an increasingly tough operating environment, which could be the case upon establishment of a 4^th telco here, dwindling profits could mean more difficulty in paying interest and repaying loans. With a weaker financial position, the company may not be able to refinance its loans at favourable rates, meaning a higher rate of interest has to be paid. 

Combined with attempting to sustain a high dividend payout, this could put substantial pressure on its already tight cash reserves, forcing the company to borrow yet more money, increasing its gearing ratio and further deteriorating its financial position, which could translate to yet higher borrowing costs in future. The simplest solution out of this vicious cycle would be to cut dividend payouts to a more sustainable level, which could send the stock price plummeting.

While I believe the possibility of such a vicious cycle playing out is quite remote, one should always take precautions and never completely discount such scenarios.

A Brief Comparison With Peers

	M1	SingTel	Starhub
Current P/E Ratio	10.7	15.9	14.8
Price/Book Ratio	5.2	2.4	24
Dividend Yield	7.5%	4.5%	6.3%
FY15 Free Cash Flow Yield	4.5%	4.4%	3.9%

From a purely valuations point of view, M1 may appear to be trading at a discount to its peers based on its P/E ratio. However, the low P/E ratio is warranted considering how exposed the company is to increased competition in the local telco industry. It reflects that investors are pricing in much lower growth into the stock in light of this.

Similarly, M1 may look like an attractive stock to own for dividend income, with a REIT-like yield of 7.5%. However, in light of worsening performance, I do expect FY2016’s total dividends to come in much lower due to poor performance. The high dividend yield may look attractive, but it is nothing but a yield trap for investors. 

Considering the sustainability of payouts among the three telcos, M1 looks the most likely to struggle with its high dividend payout with respect to free cash flow, as previously mentioned, with a dividend “headroom” of -3.0%, calculated by deducting dividend yield from free cash flow yield, again reinforcing that a dividend cut is on its way. While all three telcos have negative dividend “headroom”, the most unsustainable still looks to be M1.

From a valuations standpoint, M1 may look cheap relative to its peers, but for good reason, in view of its geographical concentration in Singapore and its susceptibility to suffering from increased competition in the local market.

What The Charts Say

With wave after wave of bad news hitting the stock, M1 has been on a steep downtrend since it hit an all time high of $3.98 in early 2015. Since then, it has lost nearly 50% of its value, with shares last changing hands at $2.06. M1 has been caught in the local market’s predicament, whereby many companies with weak fundamentals have been aggressively sold down, explaining the steep drop in M1’s stock since September. 

All the three moving averages (20,50 and 200 day) are pointing downward, indicating long term weakness for the stock price. Interim support is at the psychological $2 level, with potentially many bidders and bargain hunters looking to buy stock at that level. Immediate resistance lies at the early 2016 low of $2.20, and further up from there at the May low of $2.34. 

In the short term, I expect prices to bounce off strong support at $2 and make a run for $2.20, fueled in part by short covering, as technicals are now in oversold conditions. However, should M1’s financial results continue to disappoint (FY16 financial results come in January), the stock could resume its downtrend to way below $2. Lacking immediate catalysts such as further reports of the new telco entrant, or a market-wide selloff, a sustained break below $2 is unlikely. Short term traders could play the bounce from this level.

The Final Word

The future indeed looks bleak for M1, with deteriorating financial results and the imminent threat of increased competition. However, long term investors could see value in M1 at depressed valuations, should the company be able to weather the storm ahead and continue to grow its revenue and net profit. 

However, investors should be wary of its unsustainable and wildly fluctuating dividend payouts, and as such M1 makes a poor pick for dividend investing due to the unpredictability of dividends. One should also note that M1 has been running a net current liability position for very long, and could face short term cash flow problems should financial difficulties arise. 

At current prices the stock looks compelling if one’s investment horizon is for the very long term. However, before the new telco entrant formerly begins business, it is hard to tell if this is indeed the low point for M1. While prices have already fallen drastically, valuations are still not dirt cheap and I believe there is more downside to be discovered. 

A conservative value investor, if interested in M1, could look out for yet lower prices, perhaps in the region of $1.50, to enter for the long term. If not, as of the present, the stock makes a poor candidate for investing.

Just my two cents.