We maintain our NEUTRAL view for the telecommunication sector. The upcoming spectrum refarming exercise could lower the allocation for big cap telcos, but earnings impact is expected to be minimal. Budget 2015 will be another non-event for the sector, in our view. We expect Digi to benefit the most when GST starts 1st of April 2015 should the country’s prepaid subscribers’ usage behaviour remain unchanged. Meanwhile, Telekom Malaysia (TM) is expected to transform into a full-suite integrated communications service provider in coming weeks should the group receive approvals from the authority to implement a new business plan for P1. The move is not expected to pose any immediate threat to the mobile incumbents, given that TM would continue to focus on its strength in the fixed-line services rather than the mobile segment. There is no change in our FY14-FY15 earnings forecast for all the sector players. TM (TP: RM6.74) continued to be our top pick for the sector in 4Q14. Its near-term catalysts include: (i) potential better-than-expected synergies from P1 acquisition and (ii) more traction from HSBB2 project. We have raised our Digi target price to RM6.03 (from RM5.53 previously) after imputed higher targeted EV/forward EBITDA. Its MARKET PERFORM call rating, however, remains unchanged. We continue to have MARKET PERFORM rating on Axiata (TP: RM6.92) and Maxis (RM6.87) but see a short-term trading opportunity in the latter. Meanwhile, we reiterate our MARKET PERFORM call on small cap telco player, Redtone, with an unchanged target price of RM0.77, although its current share price has exceeded the target price. We see rooms to increase our Redtone’s earnings forecast should its contract flows continue.

Spectrums re-farming exercise – A threat to the big cap telcos? MCMC has recently been taking on a more active approach in reviewing the country’s 2G/3G spectrums (900MHz & 1800MHz band) with an intention to address the network congestion issue faced by the telcos as well as to narrow the gap between the big boys and smaller players. While the authority’s intention appears to be negative to the big cap telcos (especially to Maxis and Celcom due to their sizeable spectrum allocation) at first glance, the actual impact may not be severe, in our view. The reasons being are: (i) Cellcos are transmitting their legacy network to SingleRAN, which allowed operators to provide seamless mobile services under decent spectrums with single network, (ii) the authority is expected to ensure operators minimize network disruption during the re-farming period, thus suggesting that sudden surge in churn rate is unlikely, and (iii) new network technology may emerge as we only expect the re-farming to take place in the medium term. All in all, we concur that the big cap telecom players could potentially surrender some spectrums to the authority, but earning' impact is expected to be minimal judging from the above-mentioned reasons. Potential beneficiaries for these spectrums re-farming exercise will be Digi, U-Mobile and some smaller players.

Budget 2015. We do not expect the sector to be the limelight in the upcoming budget announcement. Having said that, we expect the authority to elaborate further on the HSBB2 project, which was announced in the prior budget. On top of that, we also wish for the government to resume its initiatives (i.e. rebate or tax relief to end-users) to encourage higher broadband usage.

GST implementation. The 6% GST implementation form 1 April 2015 onwards will allow operators to remove its tax subsidy for the prepaid subscribers. This could potentially benefit all the Cellcos should the segment subscribers’ usage behaviour remain unchanged. Based on our estimate Digi will benefit the most which could improve its FY15 net profit by 3.6%, followed by Maxis (+2.7%) and Axiata (+0.9%).

TM - a new integrated communications service's provider. The partnership and collaboration between TM, Green Packet and SK Telecom are expected to enable TM to offer a full-suite integrated communications service in Malaysia. While the detail of the business plan is only expected to be unveiled in October, we believe TM is likely to leverage its strength in the fixed-line services (with mobile elements) and targets certain sectors as well as geographical areas. Head-to-head competition with other cellcos is unlikely, in our view.

2QCY14 result's snapshot. Telco players reported mixed set of results in 2QCY14 given that 75% (or 3/4) of the big caps’ telco companies’ report cards came in within the expectation, albeit at the lower-end. Maxis was the only outliner; its results mainly negatively impacted by the on-going transformation phase, higher-than-expected market expense and lower device sales revenue. No major surprises in terms of dividend announced during the quarter. Earning guidance wise, Axiata and Maxis have, once again, lowered their FY14 guidance, where the former now expects its annual revenue growth to come in at ‘mid-single digit’ (from ‘high-single digit’ given end-1Q14 and 10.1% YoY which was set for 2014 KPI) as a result of lower Celcom performance and fluctuating forex translation. Maxis service revenue, meanwhile, is now expected to come in slightly lower than FY13 (vs. flattish growth and low-single digit annual growth guidance previously).

Service revenue YoY growth appears stagnant. Digi was the only company which reported YoY growth (at 2.8% YoY) in the service revenue (total revenue minus device sales & other's revenue (i.e. hubbing; vendor revenue & etc.)) in 2Q14 while the other two major competitors experienced either flattish or negative YoY growth, suggesting that the country’s mobile service revenue appears sluggish moving forward. For the full financial year, we expect Digi’s service revenue to achieve 4.3% YoY growth (1H14: 4.0% YoY) while Celcom to inch-up by 1.4% YoY (1H14: +0.1% YoY) followed by 1.1% YoY decline in Maxis (1H14: -4.5% YoY). Delving deeply, all the cellco players are facing similar industry trend where voice revenue continues to deteriorate as a result of increasing popularity of OTT applications while data revenue continues to grow fuelled mainly by the increasing smartphone penetration rate and higher mobile Internet usage.

Digi’s data revenue has advanced 16.1% YoY (or 4.7% QoQ) to RM598m in 2Q14, as a result of higher Internet and smartphone penetration which climbed c.3pp QoQ each to 39.2% and 41.9%, respectively. On top of that, more targeted internet campaigns and affordable smartphone bundles launched during the quarter also helped to enhance its data revenue. The higher data revenue growth more than offset its slower performance in the voice revenue segment which led the group’s service revenue to report a decent 2.8% YoY (or 0.9% QoQ) growth in 2Q14. Celcom, meanwhile, reported a flattish 0.1% YoY (or 1.0% QoQ) service revenue growth in 1H14 as it lacked new plans due to network issue. This, however, is expected to be resolved in early 4Q14 and management is confident of luring dealers’ and subscribers’ eyeballs when launching its new service plans in September/October 2014. Maxis, on the other hand, saw its 1H14 service revenue continued to be hit by lower contribution from both the voice and SMS segments. While the weaker performance in the 1H14 was within expectations (where management had anticipated its business transformation plan to cause the group to underperform in the 1H14), Maxis expect its service revenue to pick up in the 2H14 followed the introduction of various worry-free data packages and steady contributions from Home and Enterprise Fixed segments. Note that, the group’s service revenue has finally shown some reversed signs in 2Q14 (0.6% QoQ) after recorded five consecutive quarters of declining, thanks to the higher revenue contribution from the data segment.

Source: Kenanga