9M16 results came in within expectations. A third interim taxexempt dividend of 5.6 sen was announced as expected. Digi has revised and lowered its FY16 guidance following a slower YTD performance. Post results review, we marginally revised our FY16E/17E earnings by -1.6%/-1.3%, after some finetunings. Maintain UNDERPERFORM with unchanged TP of RM4.79, based on targeted FY17E EV/forward EBITDA of 12.8x (representing an unchanged -1.0x standard deviation below its 2-year mean). We believe there is room for the sector PER to de-rate, should incumbents start to lower dividend payout/payment to preserve cash for spectrums payment.

9M16 core PATAMI of RM1.26b (-10% YoY) came in within expectations, accounting for 73.3%/74.7% of our/consensus full-year estimates. Overall, the 9M16 performance was impacted by the price and data quotas-centric competition (especially the prepaid segment) and weak 1Q16 performance. As expected, it declared a third interim taxexempt dividend of 5.6 sen (ex-date: 29 November), bringing its 9M16 DPS to 16.1 sen (9M15: 17.1 sen). For the full financial year, we expect Digi to declare 21.7 sen, translating into a dividend yield of 4.3%.

YoY, 9M16 revenue declined by -5.0% to RM4.9b, mainly attributed to the lower service revenue (-1.9% as a result of the weaker prepaid segment, no thanks to lesser IDD traffic post rationalisation and also effect from continued migration of prepaid to post-paid plans) coupled with smaller devices & other revenue (-40%). Group core PATAMI declined by 10% to RM1.26b due to lower turnover and higher effective tax rate.

QoQ, 3Q16 service revenue growth levelled at -0.2% as the moderate post-paid segment (due to lower voice revenue as a result of higher takeup of entry level post-paid plans) was cushioned by stable prepaid segment following the move to step away from irrational IDD price war. EBITDA, meanwhile, improved by 5.4% with margin enhanced to 47.9% (vs. 44.4% in 2Q16), anchored by better IDD margins, stronger internet revenue contribution alongside well-managed cost structure. Digi’s total subscriber base suffered 98k net loss in 3Q16 (to 12.2m) as a result of lower prepaid subscribers(-138k) but partially cushioned by higher post-paid base (40k) as a result of stronger network. Active internet subscribers were maintained at c.7.9m or 65% of total subscribers. The group's LTE/LTE-A population nationwide coverage has reached 78%/36%, respectively, with 3.7m subscribers (or 30% of its total subscriber base).

Revised FY16 earnings guidance. The persistent headwinds in the prepaid segment have adversely led Digi to record weaker performance YTD. Consequentially, the group has revised its FY16 target on service revenue growth to low single-digit decline with EBITDA margin come in slightly below 45% (vs. flattish YoY growth target previously). Its capex, meanwhile, remained stay at c.13% of service revenue (implied c.RM800m).

No solid updates on the 900/1800MHz spectrum fee payment scheme.Similar to its key competitors, Digi is also reluctant to share more details on its method in settling the spectrum fee, and is due to pay RM598.5m (or 44% of its total fee to retain the said spectrums for 15 years) to the authority by 1st November in the form of either instalments or lump-sum payments. Although Digi has yet to decide on the preferred policy, we expect the financial impact to the group’s FY17 P&L account to be minimal (<1%) given that the spectrum fee is likely to be amortised throughout the spectrums’ useful life.

Healthy balance sheet. Digi’s net debt/EBITDA ratio remains healthy at 0.38x (well within its optimal capital structure ratio of 0.35x-0.45x), suggesting that the group still have room to gear, if needed.

Source: Kenanga Research - 20 Oct 2016