Attractive 5.4% yield for its low-risk profile
- Regulatory rate, a critical factor for the stock price, is likely to be stable amid a rising risk-free rate.
- NetLink’s distribution yield spread might narrow to 300 basis points to reflect its low risk profile; inflation should not impact distributions adversely either
- Upgrade to BUY with a revised TP of S$1.05
Investment Thesis:
With Singapore risk-free rate rising to 1.9%, NetLink’s regulatory rate is likely to be stable. When NetLink was listed four years ago, risk-free rate was 2.1%. We project a risk-free rate of 2.1%/2.2% by the end of 2022F/23F. Ahigher risk-free rate minimises the risk of a drop in the regulatory rate for the next review period over Jan 2023-Dec 2027.
NetLink’s distribution yield spread likely to narrow to 300 basis points (bps) to reflect its lower risk profile. At the current 10-year bond yield of ~1.9%, NetLink is trading at a 350bps spread vs. its own historical average of 310bps. It has big room to gear up to meet any unforeseen circumstances.
High inflation should not eat into distributions. Inflationary pressures on capex and opex are taken into consideration when regulatory return is determined under the Regulated Asset Base (RAB) model.
Valuation:
Upgrade to BUY with a TP of S$1.05as we roll forward our valuation to FY23F. In our DCF valuation, we continue to use a weighted average cost of capital (WACC) of 5.6% and terminal growth rate of 1.2%.
Where we differ:
We are conservative in our valuation. We expect annual capex to hover between S$55-60m 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.
Key Risks to Our View:
Bear case TP of S$0.90 if risk-free rate rises too sharply. If the risk-free rate rises to 2.6-2.7% (vs. our base case of 2.1%), then NetLink might trade at a 300-310bps spread at a 5.7% yield, leading to our bear case TP of S$0.90.