NetLink NBN Trust - DBS Research 2022-03-09: Attractive 5.4% Yield For Its Low-Risk Profile

• In terms of sensitivity, we estimate that each 10-basis point rise in regulatory rate would have a +1% impact on NetLink NBN Trust (SGX:CJLU)'s EBITDA and vice versa.
• When NetLink debuted on the Singapore Stock Exchange (SGX) in July 2017, the 10-year Singapore bond’s yield was 2.1%. Currently, these risk-free bonds offer a yield of 1.9% and DBS Research projects bond yields of 2.10%/2.15% by the end of 2022F/23F.
• A higher risk-free rate minimises the risk of a change in the regulatory rate of return of 7.0% for the next five years from Jan 2023 in our view.

Regulatory objective of lower residential interconnect rate can be achieved with stable regulatory rate of 7% in our view.

• The number of residential connections has risen from 1.19m in FY18 to 1.46m in FY21, rising by 21% overall. On the other hand, RAB has gone up by ~3% over the same period to ~S$2.4bn in our estimates. As such, we estimate that residential interconnect rate of S$13.80 per month could drop by 10%-12% to maintain 7.0% rate of return on RAB. This might lead to a 6% decline in NetLink's FY24F EBITDA which will start inching up again with growth in subscribers and reach a new high in FY27F.
• We don’t see any adverse impact on FY24F distributions, as NetLink is likely to normalize its distributions by debt-funding part of its capex in some years while retaining some its free cash flow in other years.

With annual operating cash flow of ~S$270m, we don’t see any issue with Netlink’s distributions of ~S$200m.

• In our model, we assume that net debt to EBITDA to remain stable at 2.0x-2.1x assuming NetLink pays distributions from its free cash flow after paying for S$60m capex from its operating cash flow. However, NetLink has mentioned in the past, that it can use debt to fund its annual capex of S$50-60m if required.
• NetLink has also mentioned that it intends to acquire similar low-risk infrastructure business in and outside Singapore with stable returns potential although there is no fixed timeline for such acquisition.

Balance sheet has ample strength to fund future capex and acquisitions.

• NetLink’s FY21 net debt of S$533 translates to net debt to EBITDA of 2.0x. Such businesses operating on regulated asset base (RAB) model can easily lever up to 5x net debt to EBITDA, implying room to raise another S$800m in debt.

High inflation should not eat into distributions.

• We expect capex and opex to rise due to inflationary pressure. However, NetLink gets a regulated rate of return based on its regulated capital base. Higher capex due to the inflation will also push up the RAB base, leading to higher absolute returns. On the other hand, higher operating costs due to the inflationary pressure will require higher revenue to get the desired EBITDA as required by the regulatory rate. This might lead to a higher interconnect rate for connections.
• As long as capex and opex forecasts submitted by NetLink to the regulator factor in the impact of inflation, NetLink should be able to secure a regulated rate based on those forecasts.
• NetLink has also hedged most of its debt at a fixed rate that comes close to 2.6%, in our estimates.

Upgrade NetLink Trust to BUY with a revised target price of S$1.05.

• The yield spread over 10-year Singapore government bonds should be at the lower end of its 300-400bps spread historically. 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%.
• We see minimal downside risks to NetLink's distributions and its strong balance sheet should be able to support any unforeseen challenges in the business.