- We maintain our BUY call on Digi at a slightly lower FV of RM5.65/share (from RM5.70/share previously) following the release of its 3Q13 results yesterday. The group reported net profit of RM449mil (+42% YoY), which brought 9M13 earnings to RM1.16bil (+21% YoY). These were broadly in line, accounting for 70% of our estimates. The strong earnings growth was mainly driven by a substantially reduced accelerated depreciation as well as strong net additions amid stable ARPUs.

- However, management guided for lower FY13F EBITDA margins i.e. at 45% (from 46% previously) due to:- (1) Higher bundled handset demand – very low margins from device sales; (2) Weaker IDD margins; (3) Higher capex on 3G coverage which was implemented ahead of schedule. We trim our FY13F earnings by 3.6% to reflect this.

- On the upside however, management confirmed that the GST, which replaces the current service tax system, will likely be treated similar as any other industry would, i.e. passed on to consumers. As Digi’s prepaid subscriber base is typically price sensitive, we would expect some initial knee jerk reaction. Net-net however, we expect FY15F earnings to improve by 12% from the move (which was factored in, in our post-Budget 2014 report yesterday).

- We see scope for further fundamental earnings improvement going forward:- (1) Completion of Digi’s network modernisation in 3Q13 will improve cost given elimination of network duplication; (2) Accelerated depreciation has reached a tail-end in 3Q13 (RM16mil recognised); (3) Continued improvement in net adds (3Q13: +279K subs) (See Chart 1) which provides incremental base for monetisation.

- Our dividend assumption factors in 100% payout ratio currently. Given yesterday’s earnings upgrade, our FY15F dividend yield increases to 5.2% (from 4.6%). FY13F dividend yields however are lowered to 4.3% (from 4.4%) given the slight downward earnings revision in this report. 3Q13 div of 5.7sen/share reflects 99% payout ratio (YTD payout ratio: 96%).

- We see possibilities of a dividend upside if Digi adopts the business trust structure, which would essentially allow it to payout dividends out of operating cash flows. A key catalyst for this would be Telenor’s funding requirement given its recent award of a telco license in Myanmar.

- From a valuation standpoint, Digi has reverted to historical average valuation (See Chart 4). Amid an inflection point in earnings from:- (1) Completion of 3G network modernisation and absence of accelerated depreciation; (2) Tax pass-on to consumers from FY15F; (3) Reversal of subscriber addition pressure since 3Q12; we think Digi is primed for a re-rating.

Source: AmeSecurities