Telekom Malaysia (TM) reported a disappointing set of results – 1H18 core net profit fell by 40% yoy to RM261m on lower revenue from the voice and data segments and higher operating expenses. Elsewhere, TM has opened up its entry-level RM79/month Unifi basic plan for all customers. This, in our view, should lead to down trading and erode margins. All in, the operating outlook remains challenging and this may lead to a revision in TM’s dividend policy. We cut our FY18-20 EPS forecasts by 14-22% and downgrade TM to SELL (from BUY) with a lower DDM-derived price target of RM3.00 (from RM4.00).

1H18 Core Net Profit Fell by 40% Yoy to RM261m, Below Expectations

TM’s 1H18 core net profit fell by 40% yoy to RM261m, accounting for 40% of the street’s and our full-year estimates. The sharp earnings decline was due to lower revenue from the voice (-8%) and data (-11%) segments and higher operating costs (+1.4%). The decline in revenue was partly attributable to a provision of RM88m, representing an estimated MSAP impact in the wholesale segment. On the cost front, TM reported higher direct costs due to increased network costs and also a higher bad debt provision attributable to a broadcasting company.

Sequentially, 2Q18 Core Pretax Profit Was 4% Higher

TM’s 2Q18 core pretax profit recovered by 4% qoq to RM158m on higher revenue (+3% qoq). A sequential decline in tax expenses lifted TM’s 4Q18 core net profit by 48% to RM156m.

Results / Conference Call Takeaways – Challenging Outlook to Persist

(i) TM sees increasing regulatory pressures, challenging landscape;

(ii) Current gross debt to EBITDA ratio of 2.59x is above TM’s internal guideline of 2.5x;

(iii) TM has provided RM88m for the MSAP impact on the group’s wholesale revenue, from 1 Jan 2018 to 30 Jun 2018. There was no mention on backdated discounts to retail customers, but we note that the Communications and Multimedia Minister has said that fixed broadband subscribers are likely to enjoy a rebate;

(iv) TM’s RM79/month, 30Mbps Unifi basic plan is now available for all. It was previously reserved for the B40 group. Despite the usage volume cap (60GB/month), we believe the low price point should lead to down trading and erode Unifi ARPUs;

(v) Total numbers of broadband customers fell by 2.4% yoy to 2.30m. The decline in Streamyx subscribers exceeded the increase in Unifi net adds;

(vi) Management is maintaining its dividend policy for now. Taking into consideration the changes in regulatory action and increasing competition, we expect TM to revise its dividend policy; (vii) Management has lowered its 2018 capex guidance to 19-20% of revenue (from 20-22%); and

(viii) TM will focus on initiatives that can contribute to revenue uplift and cost rationalization to sustain profitability. The group will focus on convergence and going digital, and reprioritizing its capex to focus on growth and leveraging on existing assets.

Cutting Our FY18-20E EPS by 14-22%

We cut our FY18-20E EPS by 14-22% after incorporating: (i) lower revenue from the wholesale segment due to the lower MSAP (Mandatory Standard on Access Pricing); (ii) lower retail broadband ARPUs (downtrading to the new Unifi basic plan); (iii) slower growth in broadband subscriber base due to stiffer competition; (iv) lower annual capex; and (v) a lower dividend per share of 14.7 sen for FY18E, based on a payout ratio of 100%.

Downgrade to SELL (from BUY) With a Lower TP of RM3.00

In tandem with our earnings forecast revisions, we downgrade TM to SELL (from BUY) with a lower DDM-derived price target of RM3.00 (from RM4.00). Given the twin headwinds of increasing regulatory and competitive pressures, TM’s operating outlook remains challenging. While we like TM’s cost rationalization initiatives, the implementation will likely be gradual and we do not expect a significant reduction in operating cost in 2018-20E. A likely revision in the dividend policy and consensus earnings downgrades may weaken TM’s share price. Key risks to our negative view are higher growth in broadband subscriptions, lower-than-expected decline in broadband ARPUs, and high cost savings from its rationalization plan.

Source: Affin Hwang Research - 30 Aug 2018