Investment Highlights

• We maintain our BUY call on Axiata Group (Axiata) with an unchanged sum-of-parts-based fair value of RM6.30/share, which translates to a rolled forward FY18F EV/EBITDA of 6.5x, half of Singapore Telecommunications (SingTel).

• We have reduced Axiata's FY17F-FY19F earnings by 5%-7% in tandem with the cuts in the group’s 66.5%-owned XL Axiata's (XL) net profit by 40%-70%, largely from an 8% reduction in XL’s prepaid ARPU assumption to IDR32/month. Our earnings forecasts for XL, which accounts for 12% of Axiata’s SOP, are now 22%-39% below consensus.

• Indonesia-based XL’s 1QFY17 normalised net profit of IDR20bil disappointed, coming in at 3% of our earlier FY17F earnings and 7% of street’s IDR298bil, due to its blended average revenue per user (ARPU) declining 15% YoY to IDR33/month vs. our earlier assumption of IDR38/month.

• Even though XL’s sales and EBITDA for 1QFY17 was flat QoQ, we acknowledge being overly optimistic on the company’s earnings growth momentum as efforts to revitalise subscriber expansion has come at the expense of ARPU. This is highlighted by the IDR7/month contraction since 4Q15 when the subscriber base rose by 6mil to 47.9mil.

• On a QoQ basis, XL's 1QFY17 EBITDA margin was largely unchanged at 35% as overall operating cost remained flat. However, the 27% reduction in depreciation charge was more than offset by higher interest expense and lower tax writebacks. Hence, normalised net profit halved QoQ.

• XL's transformation programme, focused on improving 4G adoption rates through increased coverage, modernising distribution channels via partnerships together with traditional outlets, and building online video content and data promotions, appears to be gaining some traction.

• Prepaid subscribers rose 1.5mil QoQ to 47.9mil while postpaid segment growth was only a slight 7K to 540K. Data currently accounts for 63% of 1QFY17 service revenue, up from 53% in 4Q16 and 41% in 1QFY16.

• Nevertheless, while data revenue growth is faster than traditional voice and SMS, we expect the group’s monetization capability to be constrained by competitive pressures. Also, XL’s focus on expanding network coverage outside Java is likely to garner minimal initial returns.

• With an annual capex target of IDR7bil, the current net debt/EBITDA of 1.7x (vs. 2.8x in FY15) is adequate for the group to continue rolling out its network coverage into the rest of the country.

• Axiata currently trades at a bargain FY18F EV/EBITDA of 6x, way below its 2-year average of 8.1x and less than half of SingTel's 14x. We continue to be bullish on the stock on expectations of a value-enhancing re-merger with TM, which will continue the rerating process to bridge the valuation gap with SingTel.

Source: AmInvest Research - 24 May 2017