All telcos under our coverage reported lower 1Q19 service revenue for their Malaysia operations due to lower subs, the cut in MTRs, lower wholesale revenue and / or lower ARPUs. For the cellcos, the lower revenue translated to lower profit (yoy) while TM unexpectedly announced a record core profit due to cost optimisation. Moving into 2H19, we expect the market dynamics to be similar to 1Q19. For exposure, we look beyond the headline statistics and instead for stockspecific ideas. We like TM (BUY, TP RM4.15) for its strong earnings recovery driven by cost optimisation and undemanding valuations. We also like Axiata (BUY, TP RM5.17 for the possible merger with Telenor Asia.

Overall, 1Q19 Was a Weak Quarter for the Cellcos

In 1Q19, the three cellcos saw a 3.4% yoy decline (-1.7% qoq) in their combined cellular subscribers (subs). Digi had the steepest qoq decline, followed by Axiata, suggesting stronger competition in the price-sensitive market segment and / or declining demand from foreign workers. The decline in subs, coupled with a 33% cut in mobile termination rates and lower wholesale revenue dragged the cellcos’ service revenue and profitability. All three cellcos under our coverage reported weaker 1Q19 core net profit (- 12% to -33% yoy) due to lower service revenue, higher opex (Axiata, Maxis) and the adoption of MFRS 16 (Digi, Axiata).

TM: Record Earnings on Cost Optimisation

In the fixed broadband market, TM continued to see a decline in its Streamyx subs, some of which migrated to Unifi while others have switched to competitors (Maxis, TIME.com) or mobile broadband. Notwithstanding the weaker revenue (largely expected), TM reported a record net profit that exceeded all expectations due to lower operating expenditures, arising from optimisation across all major cost components (ie, network cost for Webe Digital). The lower cost structure looks sustainable; we expect TM’s EBIT margin to improve to 14-15% in 2019-21E, from 9-12% in 2014-18.

Maintain Sector Neutral Call; Top Picks Are TM and Axiata

Operationally, we expect the telco market to remain challenging in 2H19, mirroring that of 1Q19. Against an uninspiring revenue outlook, stock-picking is key. We like TM (BUY, TP RM4.15) for its strong earnings recovery (we expect 2019E core profit to grow by 52% yoy) driven by sustained cost optimisation and an undemanding valuation of 14x 2020E PER. Elsewhere, we are positive on the possible merger between Axiata and Telenor Asia. The deal is, in our view, beneficial to the companies’ shareholders and constructive for the development of Malaysia’s telco infrastructure. Axiata (BUY, TP RM5.17) is a clear beneficiary and our preferred pick to partake in the possible merger. We are downgrading Digi to HOLD (from BUY) with an unchanged TP following the recent share-price increase. Key risks to our sector view: termination of Axiata-Telenor Asia deal, major changes at TM’s senior management team, regulatory pressures and spikes in operating costs.

Source: Affin Hwang Research - 11 Jun 2019