Investment Highlights

• We maintain our HOLD rating on Digi.Com with unchanged forecasts and DCF-based fair value of RM4.55/share based on WACC of 7.3% and terminal growth rate of 2.5%, which implies an FY19F EV/EBITDA of 12x, slightly below its 2-year average of 13x.

• We attended Digi’s lunch session today with CEO Albern Murthy, new chief financial officer (CFO) Inger Folkeson and former CFO Nakul Sehgal on the impact of lease accounting under the new MFRS 16 which takes effect on 1 January 2019.

• Under this new accounting standard, all leases which are not short term (below 1 year in duration) and low value relatively, will be included as assets and liabilities in the balance sheet. This means that operating leases will no longer be considered as off-balance sheet items.

• The potential earnings impact stems from the difference between stable lease rental expenses under the earlier MFRS 117 vs. lease finance charges, which are calculated on the outstanding lease liability on a monthly basis.

• Digi’s rental items are classified as: i) capital expenditures for indefeasible rights of use of fibre connectivity; ii) cost of goods sold for leased circuits, fibre optic charges and domestic interconnection fees; and iii) opex for site rentals of transmission towers, spectrum assignments, office buildings and kiosks.

• While management did not provide any guidance on MFRS 16’s impact on earnings for the past or current years, the group highlighted that most of its leases are currently classified as offbalance sheet.

• However, management provided a simulation based on a lease with a rental rate of RM10K/month. Discounted at 4% annually, it showed a net profit reduction of 1.8% for the initial month of the lease which is the worst affected. If we apply a 1.8% increase in Digi’s FY17 rental costs of RM398mil, this worst-case scenario impact to the group’s FY19F earnings is well below 1%.

• Hence, it will not have a significant impact on the group’s FY19F guidance for a flat service revenue and low single-digit EBITDA growth. As this is a mere accounting recognition, we highlight that this new standard does not affect the group’s cash flows.

• Nevertheless, we caution on some lingering impact from the accounting standard for revenue from contracts with customers under MFRS 15 in FY18, which largely affects the accounting treatment of handset contracts. MFRS 15 boosted Digi’s 9MFY18 net profit by RM85mil vs. a RM7mil reduction in 4QFY18.

• As device revenue is now amortised over the contract period, the reversal of the earlier MFRS 15 profit accretions could account for 5% of FY19F earnings on a normalised basis. Hence, there is a likelihood that we could lower our forecasts slightly post-1QFY19 results.

• The stock currently trades at a fair FY19F EV/EBITDA of 12x, near its 2-year average of 13x. This stems from the highly competitive landscape as subscriber growth while ARPUs remain under pressure.

Source: AmInvest Research - 30 Jan 2019