Investment Highlights

• Mixed 1Q2019 performance. The telco sector’s 1Q2019 results were somewhat mixed as normalised earnings of Maxis and Axiata came in within expectations while TM came in above due to a surprisingly sharp improvement in its cost structure which management affirmed did not include any one-off provision write-back. However, Digi.Com disappointed due to an adverse impact from the adoption of the MFRS 6 for finance lease treatment and declines in prepaid subscribers.

• TM’s impressive outperformance stemmed from a surprisingly sharp drop in operating costs, which was caused by the group's transformative Performance Improvement Programme (PIP). This in an ongoing initiative that has been carried out since mid-2018, leading to cost optimisation in unifi mobile's domestic roaming, contract renegotiation, marketing, business procurement and manpower.

• TM’s CEO position to be resolved soon. As indicated by Prime Minister Tun Dr Mahathir Mohamad, TM’s acting CEO Shazril Imri Mokhtar, who attained to his current position in November last year after only 2 weeks as the chief operating officer, is expected to be replaced by a more senior executive needed to reposition the group’s future transformation strategy.

• No upcoming broadband cuts. As Communications and Multimedia Minister Gobind Singh Deo has indicated that highspeed broadband prices will not be further cut this year, TM earnings prospects have stabilised with all of TM's Streamyx and unifi existing customers having been upgraded to faster speed packages while experiencing minimal downtrading activities together with manageable revenue declines so far.

• Celco rebound from lower costs. Cellular operators (Celco) 1Q2019 net profit rose 13% QoQ to RM887mil on lower operating costs even though revenue decreased by 10% QoQ. This stemmed largely from the absence of most of Maxis’ RM250mil one-off expenses for fibre customer retention, mobilisation of enterprise business growth, network improvement, optimisation and O&M charges for productivity initiatives which were incurred in 4QFY18.

• Total subscribers continued to contract amid tight competition and ongoing SIM consolidation, declining QoQ by 533K and 1.1mil YoY to 31mil. A major portion of the YoY decline stems from Celcom losing 649k and Digi 506k while Maxis increased by 51k. These contractions stemmed purely from the prepaid segment, which lost 704k QoQ and 1.9mil YoY to 21.8mil subscribers.

• Growing postpaid segment driving service revenue momentum. While the prepaid subscriber base continued to dwindle, the higher value postpaid segment grew 171k (+2%) QoQ and 802k (+10%) YoY to 9.2mil. This is partly offset by postpaid ARPU declining by RM3/month QoQ and YoY to RM81/month.

• Maxis remains revenue leader despite Digi’s larger subscriber base. Digi continued to command the largest subscriber market share at 36% vs. Maxis’ 35% while Celcom remained a distant third at 29%. Digi’s pole position since 1Q2016 stemmed largely from its strength in the prepaid segment, underpinned by the migrant population. However, Maxis is strongest in the postpaid segment with an ARPU and subscriber base which are 31% and 16% respectively higher than Digi’s. This places Maxis in the leading position with a 1Q2019 revenue market share of 41% vs. 31% for Celcom and 28% for Digi.

• Rerating catalysts from merger and cost optimisation drives. Prospects for the sector have structurally transformed with the proposed Telenor Asia-Axiata merger amid rising evidence of cost optimisation benefits for TM. The consolidation between the operations of Celcom and Digi will reduce the number of cellular competitors to 4 from 5 as the now dominant merged entity will be unlikely to initiate further price cuts that will only erode its bottom line. As merger synergies could take at least 2 years to materialise, Maxis will be free to pursue its converged fiberised solutions for its consumer, enterprise and business segments. Meanwhile, TM’s cost optimisation drives could be highlighted over the next few quarters, spurring growing market conviction that will catalyse further revaluation cycles.

• Upgrade sector to OVERWEIGHT from Neutral given multiple synergies from the Telenor Asia-Axiata merger, which will significantly alleviate price competition that has been eroding the sector’s margins over the past 3 years.

Hence, we have upgraded Axiata and Digi to BUYs and Maxis to HOLD. We have removed Axiata’s 25% holding company discount to its SOP-based fair value of RM5.40/share while Digi’s DCF-based fair value has been raised from RM4.42/share to RM5.45/share by reducing its WACC to 6.3% from 7.6% with a lower cost of equity of 8%. We have also raised Maxis to HOLD from UNDERWEIGHT with fair value raised from RM4.60/share to RM5.60/share from a 1ppt increase in terminal growth rate to 2%. TM remains a BUY at a fair value of RM4.08 given the radical transformation of its cost structure.

Source: AmInvest Research - 10 Jun 2019