Worst is over: Telechoice has gone through 5 quarters of sequential decline in revenue, from its peak of S$125.7m in 2Q2007 to S$55.0m in 1Q2009. 2Q2009 was the first quarter that the company posted a positive sequential growth of 28%, signaling that operating results had bottomed out.

Operating costs well contained: Admin expenses were trimmed significantly for the past two quarters. While revenue tumbled by 23% in 2Q2009, admin cost was down by a hefty 36%, reflecting management’s concerted effort to cut cost and boost margins. Jobs credit granted by government also played an important part in cost reduction.

Outlook uncertain: Although we believe Telechoice has hit the bottom in 1Q2009, a rapid recovery may not ensue. Notwithstanding that the company’s business model has stood the test of time as its operation remains profitable despite of the grip of financial crisis, some key issues need to be addressed for the company to attain a remarkable growth going forward.

PCS segment has been the core contribution to Telechoice in terms of sales and profit. Telechoice’s heavy reliance on its major customer, Starhub, could be a double edge sword. Although Telechoice has yielded stable and satisfying income from the services it provides to Starhub, its ability to grow further will be prohibited if its customer base fails to broaden and operation unable to expand overseas.

Telecoms segment has been under pressure to evolve in order to revive its previous level of profit margin. The profit margins for this segment have been heading south, from PBT margin as high as 26% in 4Q2006 to current level of 8.1%. The services and products the company offers lose its competitiveness due to lower barrier of entry and competition from first-tier telecom services providers.

Channeling more resources on existing products such as iDD has to be the last thing the company should do. Instead, more innovation on new products and services that could add value to customers is what the company needs most so as to attain a breakthrough.

Network Engineering segment is expected to fare much better than the rest of the segments in FY09 as governments made coordinated effort to stimulate their economies via investment in infrastructure. While this segment is expected to post a decent growth in revenue, its PBT margin is pretty unpredictable.

Upgrade to BUY recommendation with target price of $0.28: Our base case scenario assumes a 70% payout ratio, 1% terminal growth, 2.6% risk free rate, 0.75 adjusted BETA, 9.4% expected market return, 3% illiquidity risk and 9.95% cost of equity. Based on the DPS of 1.75 cts, 2.00 cts, and 2.25 cts for FY09-11 respectively, we derive a target price of S$0.28, which is valued at 1.88x FY09E P/B and 11.12x FY09E P/E.