Digi maintains its conviction that the current irrational price offers (for several mobile plans) is likely to be short-lived but may still take a few months for industry players to achieve equilibrium price levels. The current weak MYR may not result in any severe impact to Digi’s IDD segment as the group tends to renegotiate rates during times of high currency volatility, judging from its historical track record. There is no change to our earnings forecasts post our recent company visit. We maintained our OUTPERFORM call on Digi but with a lower target price of MYR6.10 (from RM6.63 previously), given that the market appears to be undergoing a derating process as a result of the challenging macro and currency outlook. Our renewed target price is based on a lower targeted FY16 EV/fwd EBITDA of 14.1x (from 15.3x previously), representing a +1.0 std. deviation (as opposed to +1.5 previously) above the 4- year mean.

Finding equilibrium price. The intense price competition amongst telco operators is expected to be temporary as Digi and another key player do not intend to response any further to the recent ‘price war’ initiated by both Celcom and UMobile, which launched several value-destructive plans. Although these headline packages’ prices managed to draw some subscribers’ eyeballs, it could compromise their network qualities as well as users’ experience. Management believes the big boys are still very much focused on the earnings and subscriptions while the smaller players tend to emphasis on market share, thus suggesting that the current value-destructive plans are not sustainable. Digi believes the industry may need to take a few more months to get to the equilibrium price.

Prepaid segment sentiment has yet to return to the pre-GST period. Digi indicated that its prepaid segment has gradually improved but yet to return to the pre-GST period. This is not a surprise, given consumers, especially the prepaid subscribers (which generally are more price sensitive than the postpaid users), seeing their disposable income eroded post the GST, thus leading to more cautious spending. Management believes the market may take months to neutralise the GST impact.

Weak currency may not have a severe impact on Digi’s IDD segment. Generally speaking, the weaker MYR is expected to dampen telcos’ IDD segment margins as the segment revenue is denominated in Ringgit while the traffic cost is at USD-based. Nevertheless, despite the USD strengthened by 14% against the MYR during the 4Q14-2Q15 period, the group’s traffic charges (which comprised of IDD, mobile termination fee, and fibre lease) have managed to stay at RM320m-RM330m (or 20.2%-20.4% to its service revenue) range. Apart from the cost efficiency, we understand that Digi managed to re-negotiate a better IDD traffic rate during the said period. As a result, should Digi able to maintain its efficiency, we are not surprised that the IDD traffic charges may be under control again in 3Q15 despite higher currency volatility. While Digi is reluctant to share more details on its IDD segment, we understand that the authority has revealed that Malaysia’s migrant workforce stood at 6.7m (of which 2.1m possessed valid work permits and registered with the Immigration Department) in March 2015. Thus, assuming 50% of the migrants opt for Digi’s prepaid network, we estimated that the IDD segment could contribute c.33%-49% to the group’s prepaid revenue in 1H15.

Foreign shareholding continues to narrow, in tandem with the sector peers as well as the overall broader market. Digi’s foreign shareholding has narrowed to 13.6% in Jul-15 from 14.9% in end-2Q15 and its all-time high level of 15.9% recorded in February this year. Having said that, the recent roadshows attended by Digi’s management suggested that foreigners are concerned more on the country’s macro and currency outlook rather than the company’s prospect. Thus, suggesting that foreign interests may likely to return once the country’s macro environment improved.

Source: Kenanga Research - 18 Aug 2015