Investment Highlights

• 2Q2019 performance largely within expectations. The telco sector’s 2Q2019 results were largely within expectations as normalised earnings of Maxis and Digi.Com came in within expectations while TM continued its commendable improvement in its cost structure in which management reaffirmed did not include any one-off provision write-back. While Time dotCom’s (Unrated) 1HFY19 net profit growth of 22% YoY far surpassed its tepid telco peers, this largely came within the market’s sanguine expectations.

• TM’s stronger bottom line delivery stemmed from the low operating costs which continued from 1QFY19, with 1HFY19 operating costs declining by 16% YoY to RM3.6bil. This was driven by the group’s transformative Performance Improvement Programme, an ongoing initiative that has been carried out since mid-2018, driving cost optimisation in content/sponsorship costs, contract renegotiations, marketing, business procurement and Unifi mobile’s domestic roaming arrangements.

• Negative on the rollout of the National Fiberisation and Connectivity Plan (NFCP) over a 5-year period from this year to 2023. The NFCP rollout could cost RM21.6bil, of which 50%–60% may be financed by the MCMC's Universal Service Provider fund that currently holds RM8bil. This is in line with the government's objective to recognise access to the internet as a basic right, ensuring equal access to the internet for both urban and rural residents. Given TM's role as the national broadband provider, the group will likely bear up to half of the NFCP cost, which translates to RM2.2bil over the next 5 years. Besides TM's own capex requirements, the NFCP rollout alone translates to 19% of FY20F revenue – already above management's FY19F capex target of 18% and 8% in 1HFY19. Additionally, the thrust of the NFCP towards connecting the rural population could mean that revenue accretion from these investments will be minimal.

• Improved celco earnings. Cellular operators (Celco) 2Q2019 net profit rose 14% QoQ to RM1bil on lower operating costs and lower effective tax rate even though revenue was flattish at RM5.4bil. This stemmed largely from Celcom’s improved cost discipline and Digi’s lower effective tax rate, although partly offset by the continuing decline in Maxis’ terminated wholesale 3G access arrangement with U-Mobile.

• Total subscriber trajectory flipped upwards in 2Q2019 after a 4-year continuous decline. Mobile subscribers rose 77K as postpaid additions of 216K had more than offset prepaid contractions of 139K. Maxis enjoyed the highest net accretions of 136K, followed by Digi’s 113K while Celcom continued to decrease 172K from its dwindling prepaid base.

• Growing postpaid segment driving service revenue momentum. While the prepaid subscriber base continued to dwindle, the higher value postpaid segment grew 216K (+2%) QoQ and 863K (+10%) YoY to 9.4mil. This is partly offset by average postpaid ARPU declining by RM1/month QoQ and YoY to RM80/month.

• Maxis remains revenue leader despite Digi’s larger subscriber base. Digi continued to command the largest subscriber market share at 37% vs. Maxis’ 35% while Celcom remained a distant third at 28%. 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 23% and 17% respectively higher than Digi’s. This places Maxis in the leading position with a 1H2019 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 as a result of the proposed Telenor Asia-Axiata merger as the number of cellular competitors reduces from 5 to 4. The emerging dominant player 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 reaffirmed over the next few quarters, spurring growing market conviction that will catalyse further revaluation cycles.

• Maintain OVERWEIGHT outlook on the sector given the multiple synergies from sector consolidation, which will significantly alleviate price competition that has been eroding the sector’s margins over the past 3 years. However, we have lowered our fair value for Telekom to RM3.50/share (from RM4.25/share) by lowering DCF terminal growth assumption to 1% from 2%, given the expected escalation in the NFCP-driven capex requirements.

Source: AmInvest Research - 4 Sept 2019