Is NetLink NBN Trust’s Dividend Sustainable?

IMPORTANT: Please read the disclaimer before continuing.

A friend of mine asked me about NetLink NBN Trust.

For those who are wondering what’s NetLink NBN Trust?

The trust “designs, builds, owns and operates the passive fibre network infrastructure (comprising ducts, manholes, fibre cables and Central Offices) of the Next Gen NBN.

The Trust Group is the only fibre network with nationwide residential coverage in Singapore. As of 31 December 2018, the Trust Group supports approximately 1.3 million residential end-user connections and more than 45,000 non-residential end-user connections. The Trust Group also deploys fibre to 1,462 non-building address point (“NBAP”) connections across Singapore.”

source: http://www.netlinknbn.com/who_we_are.html

In short, NetLink owns all of the underlying infrastructure that makes fibre network possible. This means, for every new fibre connection being established, NetLink earns another customer who pays a recurring subscription.

Source: Maybank Kim Eng / NetLink NBN

NetLink is able to earn incremental revenues without incremental costs. They are also the monopoly. In fact, the only player. 79.4% of their revenues are heavily regulated by the authorities meaning NetLink cannot dictate the prices they charge. As for the remaining non-RAB revenue, NetLink has flexibility to dictate the pricing.

A business needs to have pricing power. What if the costs of business go up but the business is not in a position to increase their selling prices? Their profit margins will start to decline.

Back to NetLink… they don’t sell internet packages or broadband services. They are not caught in the crossfire between all of the telcos. They stand alone as the sole supplier of fibre connections.

What’s exciting is rolling out of 5G network in Singapore. I believe NetLink will have to spend the necessary capex to support the future deployment of this technology.

The company’s net asset per unit is 75.7cts while the last traded price was 87.5cts. The Price-to-Book ratio is around 1.16x. However, we cannot say it is overvalued since NetLink NBN is essentially, a cash cow business that dishes out dividends to its shareholders. It should be valued on dividend yield approach.

Are the Dividends Sustainable?

In December 2018, I wrote an article on whether Starhub dividends are sustainable. I am going to use the same method to evaluate NetLink NBN Trust.

A quick way is to see their free cash flow.

Free cash flow is obtained by taking cash flow from operations minus purchase of property, plant and equipment.

If free cash flow is more than the dividends declared, it is okay.

If free cash flow is less than the dividends declared, it means the company is unable to self-sustain the dividends and needs to borrow money to finance the shortfall.

source: FY19 results

Plucking the numbers above, I came to the conclusion that there was a shortfall of $62.8m. It was resolved when NetLink borrowed $45m from the bank and NetLink NBN tapped into their cash pile. The cash balance dropped from $166.449m to $148.621m as of end 31 March 2019.

This demonstrated that their dividends were not self-sustaining at all.

Q1 FY20 Financials

On 5 August, NetLink released their Q1 FY20 results.

It came with very decent results. The profit after tax grew by 10%. The market is not entirely saturated and the number of installations were growing by healthy digits.

But the cash flow demonstrated another picture.

I am going to try do something quick and simple. It may not be accurate but it will be somewhat there.

Since the free cash flow for Q1 FY20 was $39.2m. I will extrapolate into full year basis by multiplying by 4. I will get an amount of $156.8m.

In the previous annual report, the company declared dividends of 4.88ct per share. Since the company has 3,896,971,100 of shares (as of Q1 FY20), the amount needed to support the dividends is $190m.

Since the free cash flow of $156.8m is less than dividends of $190m, the next year of dividends looks uncertain. The shortfall is $33.2m.

Assume 4.88cts of dividends is declared for this financial year, at the last traded price of $0.875, you will get an yield of 5.6%. But I have to tell you it is not sustainable.

Taking the free cash flow of $156.8m divided by the number of shares, I get 4.023cts of dividends. Take that and divided by $0.875, you will get an yield of  4.6%.

Bottom Line

Sustainable dividends are paid out of the cash flow generated in the business.

When the management declares dividends that are not sustainable, the company has to tap into the existing cash pile or resort to borrowings from the banks. That should be a red flag that dividend cuts are coming.

Shareholders of NetLink NBN, you may want to take this into consideration! I’m open to feedback in my simplistic analysis, feel free to leave a comment.