We are maintaining our OVERWEIGHT view on the telecommunication sector given: (i) that value buys are emerging following the recent sell-down, (ii) decent dividend yield of c.4%, and (iii) being a defensive sector, it could provide a good shelter to investors under the current volatile market. Our correlation study on the sector’s PER vs. the dividend payout ratio suggested that the sector downside risk is limited from here. This conclusion is also aligned with our earlier study on share prices vs. consensus’ target prices as well as the premium/discount study on the sector’s PER vs. the FBMKLCI (report title: Bottom Searching dated 18th of June). Moving forward, while we believe the sector’s outlook appears to be challenging, the implementation of the cluster management would allow the incumbents to sail through. There is no change to our earnings estimate for all the telcos under our coverage. Telekom Malaysia (“TM”, OP, TP: RM7.80) remains our top pick for the sector due to its: (i) 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 also continue to favour Digi (OP, TP: RM6.69) among the Cellcos due to its higher operational efficiency and better competency in monetising data. We reiterate our MARKET PERFORM ratings on both Axiata (TP: RM6.55) and Maxis (TP: RM6.68). Redtone’s target price, meanwhile, remain at RM0.87 with OUTPERFORM rating in view of the recent share price weakness which could provide a buying opportunity for long-term investors.

Sector’s forward PER has fallen to a more moderate level following the recent sell down and is being traded at 21.8x FY16E forward PER, which is not far off to the sector’s 5-year average PER of 20.8x. Our study on the sector’s forward PER and dividend payout ratio (which has a strong correlation of 91%) also suggested the former may retreat to the 19x-20x range in view of the lower dividend payout moving forward. Thus, suggesting that the sector could potentially find a temporary floor when the forward PER nears the 19x-21x range.

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 fast changing offerings and unique features to keep subscribers’ loyal. While these complicated ‘customized’ 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 to short-term margin's pressure or even trigger a price war under the worst-case scenario.

Cheaper broadband prices may lead for long-term gain. While we believe the sector could face some margin pressures as a result of the lower broadband entry prices, the impact is likely to be short-lived given consumers’ tendencies to upgrade to higher connection speeds as well as subscribing to more valued-added and Internet-related services once they have more Internet experience.

Challenging but manageable. While we admitted that the sector’s outlook appears challenging in view of the tougher economic outlook during the post-GST transition period as well as intense competition (especially in the mobile space), we believe with the adoption of the cluster management strategy (which allow operators to response instantly and enhance operational efficiency) the incumbents would be able to sail through the challenging wave. Heightened competition is not a new issue to the incumbents. In fact, the battle has been intensifying every year but most of the players’ normalised EBITDA margins were still managed to be sustained or only declining marginally. Thus, so long as there are no irrational price war and drastic changes on regulations, we believe, the incumbents’ EBITDA margins may likely to drift at their current range over the short-to-medium term.

Risks. Key risks to our positive view of the sector are: (i) heightened competition (from peers and smaller cellcos), which could potentially trigger a price war under the worst-case scenario; (ii) weaker-than-expected demand growth and margin as a result of the lower consumer spending (due to the current rising cost of living) and unfavourable exchange rate, (iii) worsethan- expected contribution from P1, and (iv) stricter regulatory measure. No that, all our telecom companies’ earnings estimates were 5%-10% below the consensus forecast. On the flips side, potential positive surprises include (i) better-thanexpected data monetisation, (ii) stronger-than-expected subscriber growth, and (iii) more traction from HSBB2 and SUBB projects. 

Source: Kenanga Research - 2 Jul 2015