Telecommunication - Rich valuations but prospects remain intact

kiasutrader

Publish date: Wed, 10 Oct 2012, 09:59 AM

Downgrading the Telecommunication sector to NEUTRAL from OVERWEIGHT as we believe that the sector's near-term catalysts have been essentially priced-in. Nevertheless, we believe the sector prospects remain intact given the consensus estimates as well as ours have yet to fully impute in the new potential upcoming catalysts (i.e. a 6% prepaid service tax hike; the final allocation of the 4G spectrum; infra and network collaborations and the introduction of a new business model) into our financial models. If these new catalysts materialise, which we believe the earliest could be seen in 4QCY12, could provide a re-rating spark again to the sector going forward. On the flip side, we believe that the sector's inflection point could happen when 1) they are limited rooms for further dividend yield compression; and 2) an increase in risk appetite, which may result in the market shifting focus from defensive to high beta sectors. On top of that, we also expect a temporary lull in share prices in the sector during the General Election campaign period. We are maintaining our OUTPERFORM calls on TM with an unchanged target price of RM6.45, based on a targeted FY13 EV/forward EBITDA of 7.6x (+2SD). Digi, on the other hand, has been downgraded to a MARKET PERFORM (from OUTPERFORM, previously) rating with an unchanged target price of RM5.20, based on a targeted FY13 EV/EBITDA of 12.9x (+3SD). Meanwhile, Maxis and Axiata MARKET PERFORM ratings and target prices remained at RM7.35 and RM6.33, respectively, based on targeted FY13 EV/forward EBITDA of 13.0x (+3SD) and 7.7x (+2SD).

Time to sell or'.While we believe that the sector's near-term developments have been essentially priced-in, the consensus as well as ours have yet to fully impute in the following upcoming catalysts into our financial models. Firstly, the deferment of the proposed 6% prepaid service tax hike; secondly, the conclusion of the 4G spectrum apparatus assignment ('AA'), which will see more products or services being introduced; thirdly, the effect of more infrastructure and network collaboration between the industry players and lastly, a new business model under the business trust framework. Should any one of these factors materialise, it will provide a re-rating catalyst to the sector.

'.continue to hold telecommunication stocks? In view of the abovementioned potential catalysts, we are still recommending investors to hold and ride the upward sector trend while waiting for the next catalyst to appear. On the other hand, for those investors, who are more risk averse, we would recommend them to trim part of their holdings to lock in profits, but they should buy in again later at lower prices as the sector is still able to provide decent dividend yields with solid operational performance during the current volatile market.

When is the inflection point? We believe that the sector's upside is limited for now following the strong share price rallies seen in the past two months, unless one of the abovementioned catalysts materialise. In fact, we are expecting a temporary weakness in share prices during the General Election ('GE') campaign period, but it should recover post the GE assuming that the federal power remains status quo. Apart from the GE factor, the other inflection point could occur when 1) there are limited rooms for further dividend yield compression and 2) the market started to shift from the defensive to high beta sectors.

Inflection point has yet to occur so far. Despite the strong YTD rallies in the sector's stocks, both Digi and Maxis still have rooms for further yield compression. Digi is currently offering a decent dividend yield of 5.2%, based on our FY13 DPS forecast of 28.5 sen. This is still far off from the group's historical 3-year lowest dividend yield of 4.32%. Similarly, Maxis still offers a strong dividend yield of 5.7%, based on our FY13 DPS forecast of 40.0 sen, as compared to its historical 2-year average dividend and lowest dividend yield of 5.12% and 4.28%, respectively. Should we adopt these lowest yields to our FY13 DPS forecast, Digi and Maxis could be valued at RM6.60 and 9.35, respectively, under a 'blue sky' scenario. On the other hand, our GE study suggests that defensive sectors (like consumer) may continue to outperform the benchmark index in the post-GE period. This is in contrast to high beta sectors (like property and construction), which tend to underperform the index during the 1-6-month period after a GE.

Time to sell telco stocks? The local telco sector has recorded an average YTD total return of 38.3% as compared to the benchmark KLCI of 9.7%. The sector's hefty YTD performance, which was led by Digi (+47.1%) followed by TM (+38.1%), Maxis (+34.5%) and Axiata (+33.5%), was mainly attributed to the stocks' strong cash flow generation capability, stable operational environment and more importantly, solid dividend commitment. Apart from that, the sector index component status and its defensive shelter status in nature have resulted in portfolio managers having to include in telco stocks when constructing their portfolios, especially during the current volatile market. While we believe that the sector's near-term catalysts have been essentially priced in, the consensus as well as ours have yet to fully impute in the following upcoming catalysts into our financial models. Firstly, the deferment of the proposed 6% prepaid service tax hike; secondly, the conclusion of the 4G spectrum apparatus assignment ('AA'), which will see more products or services being introduced; thirdly, the effect of more infrastructure and network collaboration between the industry players and lastly, a new business model under the business trust framework. Should any one of these factors materialise, which we believe the earliest could be seen in 4QCY12, it will provide a re-rating catalyst to the sector.

The deferment of the proposed 6% prepaid service tax hike.To recap, all the celco companies had on 8 September 2011 announced that they would impose a 6% prepaid service tax effective from 15 September 2011. However, given the negative response from the public and the government post the announcement, celcos have subsequently agreed to defer the plans until further notice. There have been no further updates since then, and we believe that the issue will only be re-discussed after the 13^th General Election and will likely take months before the conclusion can be finalised. While we are aware that celcos will tend to benefit from the proposed prepaid service tax hike should the government give the green light and the consumers' consumption behavior remains unchanged, there is no sign suggesting that this plan will materialise in the near term at this juncture.

The conclusion of the 4G spectrum apparatus assignment ('AA') could provide an optimistic outlook to the sector. The Malaysian Communications & Multimedia Commission (MCMC) is expected to finalise the allocation of the 2.6GHz (or 4G) spectrum and conclude the AA (Apparatus Assignment) by year-end. We understand that not all the nine players (i.e. Maxis, Celcom Axiata, Digi, U Mobile, Packet One, Asiaspace, Redtone, YTL Communications and Puncak Semangant) will receive the spectrum given that the authority has set the infra and network collaboration as part of the pre-requirements for the assigning of any blocks of the spectrum to players. The finalisation of the 4G spectrum AA will mark another corporate milestone to the local mobile operators given that players will be able to provide 4G services and more value-added services, add better user experience as well as widen its revenue streams in a more cost-effective way. We believe its impact have yet to be factored in by analysts in their forecasts due to the lack of roadmaps provided by the mobile operators at this juncture.

More collaboration = more cost efficiency, theoretically. We believe that there will be more infrastructure and network collaboration agreements being inked between the industry players in the next few months. Out of this, Celcom and TM collaboration could potentially be on top of the list. To recap, both Celcom and TM have entered into a Memorandum of Understanding ('MOU') to cooperate strategically in providing fixed and mobile solutions in February 2011. While both parties, apart from the HSBB service agreement which has been executed since June 2011, have yet to conclude and finalise the other definitive agreements under the MOU, such as 1) HSBB (transmission) and internet connectivity services for Celcom subscribers; 2) digital subscriber line access services for Celcom subscribers; fiber network system via long term lease for Celcom network; and 4) mobile virtual network operator services to TM. We do not discount that they may be potential ink some agreements in the future given the MOU is still valid at this juncture. The prolong negotiation of the MOU is expected given that there is a strong likelihood that the agreement may involve a third party ' Digi, thus adding more complexity to form a conclusion. Note that both Digi and Celcom have entered into a 10-year network collaboration agreement in January 2011, and thus any further infrastructure collaboration arising from either party going forward will need to get the consent or include the other party into the picture, in our view.

Business trust framework ' a potential new corporate structure to Telco? The business trust industry has been given a boost under the Budget 2013 proposals, including income tax, stamp duty and real property gains tax treatments similar to that of a company. Such business trust is suitable for capital intensive companies with stable cash, and the upside is that it can distribute quicker returns. Business trust, like real estate income trusts (REITs), generally commits to pay regular dividends and is free to pay any amount of dividends from its cash flow even if it does not make any profits. While the details of the business trust framework has yet to be unveiled by the government, we believe that it may potentially prompt the local telco players to study the above business structure due to their strong cash flow generation capabilities. This could provide a re-rating catalyst to the sector under the above scenario given that telcos will be able to deliver a more than 100% dividend payout ratio based on its strong cash flow.

A defensive sector that may lose steam post-General Election? A school of thought has earlier suggested that the investment community may potentially increase their risk appetites in the high beta sectors (i.e. construction and property sectors) by shifting from the defensive sectors (i.e. consumer and telecommunication sectors) in the post-General Election period (given the clearing up of uncertainties then). Nevertheless, based on our study of the past three General Elections, the high beta sectors tend to underperform the benchmark KLCI index performance in the post one week; one-month; three-month and sixmonth period after a GE while the defensive sectors tend to outperform. As a result, there is a high chance that this historical trend may continue post the upcoming 13^th General Election.

Source: Kenanga

CDB (6947)MAXIS (6012)AXIATA (6888)TM (4863)

Related Stocks

Market Buzz

2024-11-22

CDB

Welcome! Select a username of your choice.