2Q17 results were broadly in line with expectations. Although the sequential momentum was positive, aided by improved earnings at Axiata (+48% qoq), 1H17 sector earnings were nevertheless still lower by 4% yoy due to higher competition and costs (depreciation and interest expense). We had earlier cut our earnings forecasts for Digi due to a less optimistic outlook, and for Maxis to take into account the termination of the 3G Ran share agreement with U Mobile. With limited catalysts for the sector and potentially another round of price competition sparked by the 4th player, we would prefer to stay clear of the cellular space. We remain Neutral on the sector with TM as our top pick.

1H17 Sector Core Net Profit Slipped by 4% Yoy – Broadly in Line

1H17 saw earnings contract 4% yoy, due to earnings declines at Axiata (- 23.3%) and DiGi (-10.7%). 2Q17 sector earnings improved 4% qoq and 1% yoy, with the former largely driven by Axiata’s sharp earnings rebound of 48% qoq, albeit from a low base in 1Q17.

Operational Trends

Cellular operators continue to be impacted by a shrinking prepaid market although we are seeing a progressive shift towards the postpaid segment. We think that the major drivers behind this could be improving 4G coverage (77-89%) and growing demand for data, although we believe that competition has heated up as UMobile is also gaining traction in the prepaid segment. Postpaid net adds have generally been positive and with the higher ARPUs and stronger loyalty in this segment, the incumbents could benefit.

Sector Earnings Likely to Grow at a Slower 1% for 2017E

Post the results and earnings forecast revisions, our 2017E sector earnings growth is lowered to +0.7% from +2.5% yoy. The revisions were led by the lower service revenue guidance by Digi, and higher depreciation and amortisation charges coming from the 900MHz and 1800MHz that started in 2H17.

Maintain Our Neutral Rating, TM Our Sector Pick

We maintain our NEUTRAL sector weighting as we expect 2017 to be a challenging year and we do not foresee any earnings catalysts in the near term. We think that competition in the cellular space will intensify with U Mobile likely to be more aggressive in the months ahead (with more spectrum and strong shareholders, we think this is likely). For sector exposure, we like TM give the limited competitive pressure that we expect in the cellular space. Furthermore, its CY17-18E dividend yields at 3.3- 3.4% are also on a par with the sector.

Source: Affin Hwang Research - 8 Sept 2017