We reiterated our UNDERWEIGHT view on the telecommunication sector as the prolonged price war is expected to continue to hamper Cellcos’ immediate growth. On top of that, there is also a room for the sector PER to de-rate, should incumbents start to lower dividend pay-out/payment to preserve cash for spectrums payment. The financial impact of the 900MHz and 1800Mhz spectrums, meanwhile, is expected to come in a less extensive manner in FY16/FY17 than our initial expectations. In addition, we estimate that the aggregate 2x10MHz block of the 700MHz and 2600MHz spectrums could be potentially worth RM1.5b-RM2.0b. Valuation-wise, while we make no changes to all our telecom companies’ FY16- FY17 earnings estimates, pending the unveiling of the detailed spectrum payment scheme, we have changed our EV/forward EBITDA valuation time frame to two years (from FY15 onwards) to better reflect the industry’s valuation post the extraordinary dividends era. While we are keeping our UNDERPERFORM calls on Maxis and Digi, their target prices have been lifted to RM5.80 and RM4.79 (vs. RM5.75 and RM4.57 previously), respectively. Axiata’s target price is raised to RM5.40 (vs. RM5.19 previously) with stock rating upgraded to MARKET PERFORM. Telekom Malaysia (“TM”, OP, TP: RM7.20) remains our favourite pick for the sector given: (i) less competition in its fixed-line broadband business, and (ii) its inroad to become a convergence champion. OCK, on the other hand, is maintained at OUTPERFORM with an unchanged target price at RM0.93. We like OCK for: (i) its healthy cash flow on the back of escalating recurring income trend, (ii) its ability to ride with the passive infrastructure sharing trend, and (iii) its EBITDA margin expanding trend.

Budget 2017. While we do not expect the sector to be in the limelight in the upcoming budget announcement, we believe the authority will unveil the next course of action after the end of GST rebates for prepaid users. Nevertheless, we do not discount the scheme being extended for another year should the authority decide to sustain the feel-good factor ahead of the upcoming 14th General Election albeit the chances are expected to be slim due to its tight budget. Note that about 78% of the country’s 34.6m (an aggregate number from the big three mobile incumbents) total mobile subscribers are prepaid subscribers as of end-2Q16.

Spectrum issues. The 900MHz and 1800MHz spectrum fee is expected to come in a less extensive manner than our initial expectations given the fee is likely to be amortised throughout the spectrums’ useful life (c. 15 years vs. our 5- year staggered payment previously) despite the operators yet to make any official decision thus far. Meanwhile, as for the remaining spectrum bands, we reckon the incumbents would likely receive an offer of the 700MHz and 2600MHz while WiMAX players continue to hold the 2300MHz bands. Based on our preliminary guesstimate, we believe the cumulative 2x10MHz block of 700MHz and 2600Mhz could potentially be carrying a price tag of RM1.5b-RM2.0b.

Room to sector’s PER de-rating. The additional capital outlay to hold the said spectrums coupled with limited room to gear could potential lead operators to consider asset rationalisation or lower their respective dividend pay-out to preserve cash. The sector’s forward PER is currently trading at 23.6x, which is c.30% premium against the FBMKLCI’s forward PER of 18.0x. Thus, we believe, the premium could potentially be narrowed further should the operators start to lower their dividend pay-out/payment to preserve cash. Note that, the sector has traded above the benchmark index since FY11 (when incumbents started to award shareholders with extraordinary dividends), and enjoyed as high as 68% premium before tapering to current level following the less aggressive pay-out.

Change in a valuation timeframe. We have changed our EV/forward EBITDA valuation timeframe to two years (from FY15 onwards) instead of four years previously to better reflect the industry’s valuation post the extraordinary dividends' period. The lower-than-expected financial impact from the 900MHz and 1800MHz spectrums has prompted us to review our Cellcos’ target prices upward. The upside, however, is expected to be capped in view of the heavy capital outlay ahead, which could lead operators to consider asset rationalisation or lower the dividend pay-out to preserve cash.

All in, while our Maxis and Digi ratings are unchanged at UNDERPERFORM, we lifted the target prices to RM5.80 (based on targeted FY17 EV/fwd. EBITDA of 12.3x (-1.5x below its 2-year mean) vs. RM5.75 previously) and RM4.79 (based on targeted FY17 EV/fwd. EBITDA of 13.0x (-1.0x below its 2-year mean) vs. RM4.57 earlier), respectively. Axiata’s target price is moved up to RM5.40 (based on targeted FY17 EV/fwd. EBITDA of 6.8x (-1.5x below its 2-year mean) vs. RM5.19 formerly) with MARKET PERFORM rating (from UNDERPERFORM previously) after the share price corrected post our recent downgrade. Target prices for TM and OCK remain at RM7.20/RM0.93, respectively, with unchanged OUTPERFORM ratings.

Source: Kenanga Research - 7 Oct 2016