After SingTel's successful listing of NetLink Trust (NLT) in July, SingTel has reduced its effective stake in NLT to 24.99%. In the process, SingTel received a huge windfall, with an excess of $1 billion in cash. There has been much speculation of whether a special dividend would be declared. 

SingTel is expected to use some of these proceeds to pare down its debt or to expand its core business. As for the remaining IPO proceeds, I believe that there is a chance for a special dividend to be declared. The focus on my post would be to evaluate whether SingTel's ordinary dividend payout is sustainable, given that heightened competition in our local market is expected once TPG enters our local market as the 4th telco operator.

TPG's entry to heighten competition

With the local market saturated and TPG Telecom's impending arrival, telecommunications stocks here have taken a beating. While the share prices of its peers, StarHub and M1 have both declined substantially, SingTel has only experience a 10% fall, from its 52-week high of $4.09 to $3.74 today. Investors probably view SingTel as the safest among the 3 incumbents, as SingTel derives nearly 70% of its net profit from Australia and its Regional Associates. Therefore, SingTel would be the least affected by competition in the Singapore market. 

Singapore's current mobile penetration rate stands at approximately 150%, thus the saturated local market has little room for further growth, apart from an increasing popultaion. The arrival of a 4th operator would only reduce the market share of the incumbents. SingTel's advantage in this case would be that its earnings has been well supported by the dividends it receives from its regional associates in Thailand, Indonesia, the Philippines and India.

From the graph above, the amount of dividends that SingTel receives from its regional associates has been rising over the past five years. Given that our local telecommunication market is already saturated, opportunities for growth would have to come from outside Singapore. Although the mobile penetration rate in our neighboring counties are mostly in excess of 100%, growth can still be driven by increases in ARPU, as demand for data services means that consumers would switch to higher value mobile plans.

Sustainability of Dividends

Telecommunications are generally viewed as a defensive sector, and preferred by income seeking investors. SingTel's dividend policy is to distribute between 60 to 75% of its underlying net profit as dividends. For FY2017, SingTel paid out dividends of 17.5 cents per share, which represented a 73% payout ratio. 

To evaluate whether SingTel's dividend payouts are sustainable, I have compiled SingTel's dividend payment record for the past 5 years. 

A crucial metric that I've looked at would be SingTel's dividend payout as a percentage of free cash flow. Free cash flow (FCF) is calculated by deducting capital expenditures (CapEx) from operating cash flow (OCF). As SingTel has to expand and maintain its  telecommunication networks, it incurs capital expenditures, which may be rather intensive from time to time. SingTel's capex comes in two forms - property, plant and equipment, which represents physical assets, and intangible assets, such as licenses and spectrum rights. For example, SingTel paid $573.6 million earlier this year in April to acquire the spectrum rights.

SingTel stated in the footnote of its annual report that their reported FCF was calculated from 'cash flow from operating activities, including dividends from regional associates, less cash capital expenditure'.

However, I realised that if we calculated FCF this way, we would be excluding purchases of intangible assets, such as spectrum rights, which are an integral part of SingTel's business operations. Although the sum spent on the purchase of intangible assets is relatively small, accounting for around 10-30%, compared to the bulk of SingTel's capex  on physical assets (PPE), I believe that considering this figure would provide us with a better understanding of SingTel's free cash flows.

As I have calculated, if we were to use FCF including capex on intangible assets, the amount of dividends that SingTel distributed would exceed its FCF, which gives us a FCF payout ratio of above 100%. Ideally, a company should not pay out more in dividends than its FCF, as the shortfall would have to come from its cash balance or proceeds from its cash flows from financing activities. Having its dividend payout ratio consistently exceeding FCF would mean that we do not have a margin of safety in the event of an earnings decline.

Future Outlook

I believe that once TPG starts operations here, a price war would be inevitable. However, the market has probably priced in the expected decline in earnings from local subscribers. SingTel and the other incumbents have already began to roll out new price plans with attractive offers, in order to retain customers. Assuming TPG comes in with an aggressive pricing strategy, the incumbents may have to further lower their prices to compete. 

For FY2018, the huge cash inflow from the NetLink Trust IPO proceeds would probably help SingTel sustain its dividend payout. However, with increased competition in the near future, maintaining a FCF payout ratio of above 100% may mean that any decline in earnings would be accompanied with a cut in dividends.

My Valuation

Calculating the average FCF including intangible assets for the past 5 years, we arrive at an average adjusted FCF of $2,898 million. If we want to be slightly on the side of caution, and we require a more conservative FCF payout ratio of 90%, dividends payout should be approximately $2,608 million, or 16.0 cents per share based on 16,340 million shares outstanding. Thus, depending on our expected yield, we can they decide on a reasonable entry price. At SingTel's closing price of $3.74 today, a dividend of 16.0 cents would give us a yield of around 4.3%

Personally, as I believe telcos are a defensive sector, I would be satisfied with a yield which is closer to 5%. 

Note: I am vested in SingTel at an average price of $3.67

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  1. Hi, i was wondering if you include the dividends from JV and associates which tend to be a large part of the cash flow.

    I don't remember the cash flow to be that tight.

    On another note, the telecom are facing competition now as we see it, so whats to say the impact of TPG will be big. they are engage in the same price war when Singtel is getting an exclusive iphone distributorship.

    1. Hi Kyith,

      Thank you for visiting my blog! As I'm unable to include screenshots of SingTel's annual reports here to explain my calculations, I'll drop you an email to let you know how I derived the FCF. I understand that there's no fixed method to calculate FCF, so please do let me know if your feedback!

      With regards to the price war, my perspective is more that as our local market is already saturated, having a 4th telco would means that the pie would have to be split among 4 operators instead of 3, and that may lower earnings.

    2. Hi, i think your number may be correct. I remember the fcf yield is around 5.3%. so it might not be too far off. the idea is if one person comes in and take the pie, everyone feels someof the pain. more so if everyone have such a tight payout ratio.

      but singtel do have a few pie. their singapore pie is actually not that big relative to the group's number.

      one angle you wish to explore is that, in the future the telecom operators will more resemble a tech company like accenture and st electronics. so in this case, wouldn't the pie for singtel's NCS be more challenging? some thoughts.