XL Axiata (XL)’s 9M16 results came in below expectations due to: (i) lower service revenue, and (ii) higher-than-expected marketing and finance costs. No dividend was announced during the quarter, as expected. XL’s management maintains its EBITDA growth rate and margin for FY16 but foresees a challenging time for top line target following the uninspiring 9M16 performance. All in all, we lowered our Axiata’s FY16E/17E earnings by 3.1%/1.8%. Maintained MARKET PERFORM but with lower TP of RM5.34.

XL’s (a 66.4% owned subsidiary of Axiata) 9MH16 normalised NL of Rp250b (vs. net profit of Rp74b a year ago) came in below our and the street’s estimates, where the street’s estimates as well as ours were targeting net profit of Rp428b and Rp232b for the full-year, respectively. On reported basis, its net profit improved significantly to Rp160b (vs. – Rp507b in 9M15) as a result of the strengthening of the Rupiah against the USD and a one-off gain from the sale of towers to Protelindo in 2Q16. Note that the normalized net loss was derived after removing Rp330b unrealized forex gain, Rp372b accelerated depreciation, Rp484b loss from capital lease, Rp59b severance payment and Rp25b of tax impact. The negative variance on our end was mainly due to the: (i) lower-thanexpected interconnecting as well as the service revenue, and (ii) higherthan-expected sales & marketing expenses as well as the finance cost.

YoY, 9M16 revenue dived by 5% to Rp16.1T, no thanks to the lower interconnect revenue (-26%, due to lower off-net traffic) coupled with a softer service revenue (-3% to Rp13.8T) performance as the growth in data services was not enough to offset a decrease in revenue from Legacy Service – Voice and SMS. XL’s total customer base has increased by 1.0m to 45.0m with blended APRU reduced to Rp36k (vs. Rp37k in 2Q16 as a result of stronger take-up in its value plans). Its smartphone users grew to 27.1m with 60% penetration rate as opposed to 39% a year ago. EBITDA, meanwhile, was enhanced 3% with margin improved by 290bps to 38.6% following a reshape of the customer base as well as more stringent cost control measures.

QoQ, XL’s revenue was flat at Rp5.3T despite service revenue managed to reverse its declining trend and grew by 2%. EBITDA, meanwhile, softened by 4% with thinner margin of 37.7% (vs. 39.3% in 2Q16) as a result of higher leasing costs (due to the impact of the tower sale) and sales & marketing expenses (to build awareness with the 3G U900 & 4G rollout).

Outlook. XL remains hopeful to achieve better EBITDA growth rate (higher than its top line growth) in FY16 with margin in the high-30s due to better products and customers’ mix. However, XL’s revenue target (to be within or better than the industry average of c.10%) remains challenging following the uninspiring 9M16 performance. Capex, meanwhile, is expected to come in below Rp7.0T with key spending focused on its 4G technology development. With the three-year transformation agenda moving into Year 2, XL has successfully completed its balance sheet management objectives to reduce gearing and minimize the impact of forex fluctuations. While we understand that the rationale for this transformation is to adapt to the changing market dynamics and focus on value creation, the heightened competition and the impending 2.1Mhz and 2.3Mhz spectrum allocations could potentially shape its near-term performance.

Target price lower to RM5.34. We have reduced our Axiata’s FY16E/17E earnings by 3.1%/1.8% after lowering XL’s FY16/FY17E earnings by 87%/12% to Rp55b/Rp845b, respectively. Maintain MARKET PERFORM but with a lower TP of RM5.34 (from RM5.40 previously) based on targeted FY17E EV/forward EBITDA of 6.9x, representing an unchanged -1.5x SD below its two-year mean.

Source: Kenanga Research - 31 Oct 2016