We reiterated our OVERWEIGHT view on the telecommunication sector as values have emerged following the recent sell-down. On top of that, the current market uncertainties could also bode well to the defensive sectors like telecom. Meanwhile, 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. Despite the sector’s aggregate service revenue weakening by 1.7% QoQ in 2Q15, its normalised EBITDA remained intact with margin improving by 160bps QoQ to 49.2%. Nevertheless, with the unfavourable forex outlook, we do believe that there is a risk for Cellcos to face some margin pressures (especially on the interconnection costs) in the coming quarters. On the upcoming Budget 2016, we do not expect any material goodies for the sector except more guidance on the already announced HSBB2 and SUBB projects. Meanwhile, the latest MCMC’s statistics indicated that MVNO players have continued to gain more subscribers’ market shares (at the expense of the big boys) in the postpaid rather than the prepaid segment, thus, suggesting that the big incumbents may need to find ways to defend their territories. Valuation-wise, we make no change to all our telco companies’ FY15-FY16 earnings’ estimate. We reiterate our OUTPERFORM call on TM (TP: RM7.33) and Digi (TP: RM6.10) while keeping our MARKET PERFORM call on Axiata (TP: RM6.05), and Maxis (TP: RM6.68). TM remains our favourite pick for the sector given: (i) less competition in its fixedline 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 (i) higher operational efficiency, (ii) better competency in monetising data and (iii) decent dividend yield. Redtone, on the other hand, is maintained at MARKET PERFORM with an unchanged target price at RM0.61.

No major surprises. The sector incumbents’ 2QCY15 generally came in within expectation. While the top three mobile carriers’ aggregate service revenue weakened by 1.7% QoQ to RM5.4b in 2Q15 (mainly due to the weak consumer spending post GST implementation), its normalised EBITDA has improved by 1.8% to RM2.6b with margin enhanced to 49.2% (vs. 47.6% in 1Q15) as a result of lower quantum of foreign exchange losses in Maxis. Meanwhile, TM’s 2Q15 performance continued to strengthen with higher normalized EBITDA margin (32.1% vs. 30.2% in 1Q15) despite P1 remaining in the red.

Budget 2016 is expected to be uninspiring to the sector. Nevertheless, we expect the authority to provide more colours on the HSBB2 and SUBB projects, which were announced during prior budgets. Sector’s PER has fallen to a more appealing level following the recent selldown and traded at 21.8x FY16 forward PER (vs. the 5-year average PER of 21.0x). As compared to the FBMKLCI’s forward PER, the sector is traded at 29% premium, which is close to the 5-year average premium of 28%, suggesting that a temporary bottom could have been reached.

Postpaid segment – the real battle place. The country’s MVNO players have continued to widen their postpaid subscribers’ market share to 11.6% in 2Q15 (vs. 1Q15: 11.4%; 1Q13: 3.5%) at the expense of the big three incumbents. Hence, there is urgency for the big boys to defend their territories. On the prepaid segment front, the top three incumbents have defended the subscriber’s market share relatively well at the expense of MVNO players. Digi (28.1%) continued to rank the top, followed by Celcom (26.5%), Maxis (25.4%) and MVNO players (20.0%).

Floor and ceiling prices. While we believe that a temporary bottom could be found from here, there is a risk for the incumbents’ share prices to continue seeking bottoms in view of the unfavourable forex outlook and political uncertainties. Hence, based on our discount/premium to consensus’ target price study, the floor fair value of Maxis, Axiata, Digi and TM could potentially form at their respective -2.0x SD levels with upside capped at +1.0x SD levels (Please refer to figure 8 for details).

Risks factors. Irrational price competition remains the key risk factor for all Cellcos. Apart from that, other key risk factors are: (i) Digi - higher-than-expected traffic cost; (ii) Axiata – regulation and currency risks in its overseas venture while upside risks may come from stronger-than-expected operational performance and dividend surprise, and (iii) Maxis – higher-than-expected subscribers’ churn and positive dividend surprises. For TM, key upside risks would be positive earnings and/or dividend surprises while larger-than-expected P1 losses and intense competition on its Internet segment remain its key downside risk.

2QCY15 result's snapshot. The sector incumbents’ 2QCY15 report cards generally come in within expectation. Top three mobile incumbents’ aggregate service revenue weakened by 1.7% QoQ in 2Q15, after Celcom and Maxis’ service revenue dipped by 3.4% and 1.6%, respectively, while Digi was flat (+0.1%). The lackluster service revenue growth was mainly led by the weak consumer spending post GST among the prepaid subscribers. Celcom, meanwhile, has introduced several value plans in 2Q15 and managed to lure a total of 61k subscribers’ net adds, bringing its total subscribers to 12.3m. The aggressive customer acquisition, however, was somehow nullified by thinner margin where Celcom’s reported EBITDA has declined to RM663m (-6.6% QoQ) with margin (over its service revenue) narrowing to 39.6% (1Q15: 40.9%). Maxis, on the other hand, recorded a lower subscribers’ net adds of 49k (vs. 100k-560k average per quarter since 2Q14) in 2Q15 due to the slower take-up in its prepaid segment. Despite the GST hiccup, Digi’s service revenue remains relatively stable with reported EBITDA margin continued to stay at c.50%. Meanwhile, TM’s 2Q15 performance continued to strengthen with higher reported EBITDA margin (32.4% vs. 30.2% in 1Q15) despite P1 remaining in the red.

Budget 2016. While we do not expect the sector to be in the limelight in the upcoming budget announcement, we believe the authority will elaborate further on the HSBB2 and SUBB projects, which were announced in the prior budgets. TM has earlier indicated that the details of HSBB2 and SUBB have finally been concluded with the authority, and agreements are expected to be sealed within months. To recap, TM has received a letter of award from the government of Malaysia on 25-March for the implementation of High-Speed Broadband Phase 2 (HSBB 2) and Sub Urban Broadband (SUBB) project to deliver an end-to-end HSBB infrastructure. According to the 11th Malaysia Plan, the HSBB 2 proposes to cover all state capitals and selected high-impact growth areas that will see 250k ports encompassing 410k premises by end-2016. It also eyes 100Mbps broadband being made available to all households in the areas involved by 2020. On the other hand, under the SUBB initiative covering suburban and rural areas, it is targeting additional 420k ports encompassing 750k premises will be installed within five years from the start of the project with 20 Mbps broadband made available to 50% of households by 2020.

Sailing on the challenging wave. The big three cellcos’ aggregate service revenue remained lacklustre in the 1H15 (flat on YoY to RM10.8b) as a result of diminishing Voice and SMS segment revenue but partially cushioned by higher Data segment income. Heightened competition remains the key highlights for all cellcos over the past few quarters, where the smaller/MVNO players continued to disrupt the market through the introduction of more value plans. Celcom, meanwhile, has joined the battle more aggressively since April following the improvement of its IT transformation issues and to address its shrinking customer base concern. The aggressive move has led to Digi and Maxis launching several value plans subsequently to defend their respective market shares. Nevertheless, all the key players believe that the current valuedestructive plans are not sustainable over the long-term, and the industry may need a few more months to get to the equilibrium level. All in all, we believe the current value-destructive plans are unlikely to prolong given profitability will be the ultimate goal for all carriers. On the operating cost front, interconnection cost appears to be one of the biggest challenges for all carriers judging from the recent sharp depreciation in MYR (against USD) given that the traffic cost is USD-based. While Digi appeared to be hardest hit as a result of its sizeable foreign subscriber's base, we believe the impact could be manageable in view of its higher-cost efficiency and ability to re-negotiate (a better IDD traffic rate) under the higher currency volatility period.

Postpaid segment – the real battle place. The latest MCMC’s statistics indicated that MVNO players have continued to gain postpaid market share at the expense of the big three players (especially from Maxis and Celcom, figure 1). MVNO players have continued to widen their postpaid market share in 2Q15 to 11.6% (vs. 3.5% in 1Q13), in tandem with the growing country’s postpaid subscriber’s base to 8.4m (vs. 1Q13: 7.5m). A survey prepared by Frost & Sullivan in late 2014 suggested that the lack of transparency in pricing and subscription plans was the key reason driving customers away from their telco service providers. On top of that, we also believe better network quality and attractive bundling service also play an important role for cellcos to lure new subscribers. Note that the number of mobile number porting request has surged more than double to 613k in 2Q15 (vs. 276k in 1Q13, figure 4), suggested that the big three may need to put more efforts to defence their postpaid market share.

Prepaid segment – a relatively stable landscape. Although most of the country’s mobile subscribers are the prepaid users (c. 81%-82% range), the subscribers' competition landscape within the segment remained relatively stable with the top three players continuing to gain market share at the expense of MVNO players. Both Digi and Maxis have continued to widen their market share marginally in the prepaid segment in 2Q15 at the expense of Celcom and MVNO players despite heightened competition (figure 2). 

Source: Kenanga Research - 6 Oct 2015