In a tight spot

Although funding issues for future spectrum re-farming exercises are not expected, any increase in competition intensity or a larger-thanexpected payment could thwart FCFs and may put dividends at risk. With the government’s commitment on reducing its fiscal deficit and new competition trying to carve out market share, the risk is real. Meanwhile, sector dividend yields are already unappealing while the increased risk does not support the sector’s premium valuations. Maintain sector Underweight rating with DiGi for preferred exposure.

Cellcos can juggle spectrum cost and dividends, but risk is there

The government managed to raise upfront fees of RM2.7bn from the recent round of spectrum reallocation (for the 900Mhz and 1800Mhz bands), or the first of three lined up till 2018. While there is sufficient capacity for the cellcos to juggle spectrum cost and dividend commitment, we think that dividend upside will be capped, while downside risk is enhanced. Should the cost of future spectrum be higher than anticipated or competition accelerates, the threat of lower dividends would be real.

Competition more rational, for now

On a more positive note, irrational competition which has eroded revenue and profitability of the 3 incumbent cellcos over 2014-15, has somewhat dissipated in recent months. We would nevertheless not discount further price competition from the fourth player, U Mobile, which has gained traction; with better spectrum allocation, it will be an even more formidable player. Webe, which was recently launched, remains a niche player, but can be a potential threat with its strong parentage and their ambitions.

3Q16 results season – broadly in line

9M16 core earnings for the telcos fell a sharp 27% yoy but were broadly in line with expectations, with the exception of Axiata. Sequentially, earnings picked up, although largely due to the 2Q16 low base. On the whole, earnings for the telcos were generally impacted by more intense price competition and start-up losses. We had downgraded Axiata to a Sell due to continued earnings disappointment and the lack of a re-rating catalyst.

Maintain UNDERWEIGHT

Although stock prices have corrected and the sector has underperformed the broader FBMKLCI, sector valuations remain lofty. We think that this could be attributed to a combination of reasons including the sector weighting and its liquidity. The sector’s Shariah compliance status also helps in its positioning, especially amongst domestic funds. Nevertheless, against a backdrop of unattractive valuations and yields that have turned less compelling (because of the earnings contraction), and the lack of a rerating catalyst, we remain sector Underweight with DiGi (DIGI MK) as our sector top pick given its ability to sustain dividend payouts, growing revenue market share and most appealing yields.

Valuations and recommendation

Sector still trading at valuation premium …

Although stock prices have corrected ytd and the sector has underperformed the broader FBM KLCI, sector valuations remain lofty at an average 2017E PE of 23x. We think that this could be attributed to a combination of reasons including the sector weighting in the FBM KLCI and its liquidity. The sector’s Shariah compliance status also helps in its positioning, especially amongst domestic funds. Hence, despite unattractive valuations and yields that have turned less compelling (because of the earnings contraction), the sector remains a crowded trade for the above reasons.

… which in our view is not justified

On the whole, the PER multiples are generally not far from their peaks (respective companies’ PER bands in Fig 23-26) while dividends yields are significantly lower (Fig 21), having more than halved since their peak in 2012 and near their 5-year lows. This, in our view, does not justify the premium valuations. Moreover, with the potential risk of lower dividends ahead, the valuation premium is even less justifiable.

Maintain Underweight

Against a backdrop of unattractive valuations and yields with a lack of immediate re-rating catalysts, we remain sector Underweight. Furthermore, with a rising US interest rate environment (and potentially a rise in Malaysian Government Securities’ yields), we believe that there is further scope for sector underperformance (Fig 22). For sector exposure, DiGi is our sector top pick given its ability to sustain dividend payouts, growing revenue market share and most appealing yields.

Source: Affin Hwang Research - 6 Dec 2016