We maintain our SELL rating on Telekom Malaysia (TM) with a lower DCF-derived price target of RM2.25 in view of intensifying competition, declining ARPUs, weaker profitability and a rising risk premium. Notwithstanding a 59% ytd-2018 slide in TM’s share price, we believe the worst is not over, in view of the downside risks in consensus earnings forecasts, likely revision of dividend policy, rising competition and possible exclusion from the FBM KLCI Index.

Rising Competition, Possible New Entrants

The government seeks to heighten competition in the telecom sector (reported The Edge Financial Daily) and foreign telcos have expressed interest to participate in the local fibre fixed-broadband market, said The Malaysian Reserve. The threat of possible new entrants (ie, TNB, local companies with foreign tie-ups, international companies) and intensifying competition among the existing broadband service providers (ie, TIME, Maxis) should challenge TM’s market dominance and profitability.

Unifi Prices Have Likely Stabilised; Streamyx Prices at Risk

Following a 39% reduction in Unifi’s basic package price and the upgrade of broadband speed, we do not expect further cuts in broadband package prices over the next few quarters. However, we see downside risk to the Streamyx package prices, where TM has yet to make any reduction. It was reported that Communications and Multimedia Minister Gobind Singh Deo wants to tackle the Streamyx issues immediately.

High Operating Leverage – Revenue Slip to Hit Earnings Hard

We cut our FY18-20E core EPS forecasts by 6-18% after imputing lower Unifi prices, higher A&P expenses and weaker subscriber growth of 1% (from 2%). We forecast TM’s 2019-20E revenue to decline by c.RM900m-RM1bn from the 2016-17 (pre-broadband price cut) level of RM12.1bn. Constrained by its high fixed costs and finance charges, the revenue dip should have a material impact to its earnings and dividend per share.

Maintain SELL With a Lower TP of RM2.25

We maintain our SELL rating on TM with a lower DCF-derived price target of RM2.25 (from RM3.00) after incorporating our earnings cut and a higher risk premium of 8.2% (from 7.4%). De-rating factors include a potential Streamyx price cut, consensus earnings cut and possible exclusion from the FBM KLCI Index. Upside risks: robust broadband ARPUs, strong subscriber growth and material decline in operating costs.

Source: Affin Hwang Research - 16 Oct 2018