We raised our telecommunication sector rating to OVERWEIGHT from NEUTRAL previously as values emerged followed the recent sell-down. Meanwhile, the current market uncertainties could also bode well to the defensive sector like telecom. The sector’s aggregate service revenue and the normalised EBITDA margin remain intact in 1Q15 despite total subscribers fell for the first time since 1Q14. Our correlation study on share prices vs. consensus’ target prices as well as the premium/discount study on the sector’s PER vs. the FBMKLCI suggested that the sector downside is limited from here. On a corporate front, Telekom Malaysia (“TM”) and Digi could have reached/closed to their temporary bottom while Maxis and Axiata may have another 2%-4% downside from here. Competition in the mobile prepaid and postpaid segments appeared escalating followed the recent launch of various aggressive offers by incumbents. These could potentially lead to higher operating costs and lower margins moving forward. Valuation-wise, while we make no change to our telco companies’ FY15-FY16 earning's estimate, we have trimmed all our Cellcos’ targeted standard deviation (“SD”) levels by 0.5x each to account for the challenges ahead as well as shifting our valuation based year to FY16. TM (OP, TP: RM7.80), meanwhile, valuations remain unchanged as we had rolled over our valuation base year previously. We reiterate our OUTPERFOM call on TM and Digi (TP: RM6.69 ↓ from RM6.87 previously) while keeping our MARKET PERFORM call on Axiata (TP: RM6.55 ↓ from RM6.77 previously), and Maxis (TP: RM6.68 ↓ from RM7.06 previously). TM remains our favourite pick for the sector given (i) the lesser competition in its fixed-line broadband business, (ii) potential better-than-expected synergies from P1, and (iii) more traction from HSBB2 and SUBB projects. Meanwhile, we continue to favour Digi among the Cellcos due to its higher operational efficiency and better competency in monetising data. Redtone, on the other hand, stock rating has raised to OUTPERFORM followed the recent share price weakness. Its target price, however, remain unchanged at RM0.87.

Mobile Incumbents’ 1Q15 result remained solid despite intensifying competition and challenging economy outlook. While the aggregate top three mobile incumbents’ subscribers have fallen for the first time in 1Q15 (since a year ago), the service revenue managed to buck the trend and grew by 0.8% YoY (after suffered four consecutive quarters of negative YoY growth) with the normalised EBITDA margin remained at 47.6%, a similar quantum to the preceding quarter.

Firing all cylinders in both the prepaid and postpaid segments. All the mobile players have adopted aggressive marketing approaches in both the prepaid and postpaid segments recently. On the prepaid segment, incumbents tend to differentiate themselves through altered various offerings rapidly and unique features to keep subscribers’ loyal. While these complicated ‘customize’ plans could draw subscribers’ attentions, it could also lead for higher operating and marketing costs moving forward, in our view. On the postpaid segment front, incumbents tend to lower their offer price on top of bundling with higher values. Thus, these could potentially lead for short-term margin's pressure or even trigger a price war under the worst-case scenario.

Strong correlation between share prices vs. consensus’ target prices. Our study suggested that the premium/discount against these two variables has a strong correlation of c.95%-99% and trade at between the +2 standard deviation (SD) and -2SD-level over the past 5-year. Nevertheless, the premium/discount rate range has been narrowed to +2SD to -1SD for the Cellcos since CY13 while the fixed-line operator remained its usual trading range. These suggested that TM and Digi could have reached/closed to their temporary bottom at RM6.68 and RM5.60, respectively, while Maxis/Axiata may see another 3.4% (to RM6.26)/2.6% (to RM6.31) downside from here.

Sector’s PER has fallen to a more appealing level followed the recent sell down and traded at 22.2x FY16 forward PER vs. the 5-year average PER of 20.8x. As compared to the FBMKLCI forward PER, the sector’s PER is traded at 31% premium, which is close to the 5-year average premium of 27%. In fact, based on the historical past two-year performance, the sector’s PER tends to have 27%-52% premium (or at between the mean to +1SD-level range) against the consensus FBMKLCI forward PER, thus suggested a temporary bottom could be found from here.

Lowered our Cellcos’ targeted EV/forward EBITDA by 0.5x each after taking the following factors into consideration: (i) potentially higher than expected margin pressure as a result of heightened competition in both the prepaid and postpaid segments, and (ii) higher market risk as a result of the upcoming sovereign debt rating review, which could dampen the country’s currency outlook further should there is any unfavourable outcome.

1QCY15 result's snapshot. The sector incumbents’ 1QCY15 report cards are generally come in within expectation. Mobile incumbents’ aggregate service revenue, meanwhile, inched higher by 0.8% in 1Q15, after suffering four consecutive quarters of negative growths since 1Q14. The decent growth was mainly driven by Maxis, which reported a strong 4.4%% YoY jump (as a result of the low base effect), but largely offset by the weaker performance in Celcom (-4.4% YoY) that mainly dampened by its BSS issues. Digi, meanwhile, continued to perform and recorded 2.2% YoY growth in the service revenue, thanks to the double-digit Data revenue growth (vs. mid-single digit's growth in both Celcom and Maxis). TM, on the other hand, reported a seasonally low 1Q15, where its core PATAMI was lowered by -7.6% YoY due to the higher OPEX, forex losses and consolidation of P1. Having said that, TM is maintaining its headline KPIs for FY15 consisting revenue and EBIT growth of 4.0%-4.5% each. Note that, these headlines KPIs exclude P1, HSBB2, SUBB and other mega projects.

Aggregate subscribers fell for the first since 1Q14. The country’s 1Q15 aggregate top three mobile subscribers have fallen to 36.16m, or -91k lowers in contrast to the preceding quarter, marking the first negative subscriber growth since 1Q14. The decline was mainly led by the prolong BSS issues in Celcom that resulted the group to loss 690k subscribers net adds during the quarter. On top of that, we also believe the intensify competition from the tier-2 or MVNOs players, especially from U Mobile, which has embarked various aggressive marketing campaigns to lure subscribers recently, is another reason to cause the lower subscribers’ net add in the big three Cellcos. Prepaid segment, meanwhile, remains the battle ground since a year ago when Cellcos started to turn more aggressive in expanding their market share.

Source: Kenanga Research - 18 Jun 2015