XL Axiata (XL)’s FY16 results came in below our but above market expectations due to: (i) lower service revenue, and (ii) higher-than-expected marketing costs. No dividend was announced during the quarter, as expected. Moving forward, XL is expecting its top-line annual growth rate to come in similar to the industry average with EBITDA margin staying at the high thirties. We make no changes to our Axiata’s FY16E/17E earnings forecast for now. Maintained MARKET PERFORM with unchanged TP of RM4.81.

XL’s (a 66.4% owned subsidiary of Axiata) FY16 normalised NL of Rp209b (vs. net profit of Rp51b a year ago) came in below our (+Rp42b) but above street’s estimates (-Rp467b) On our end, the key negative variance was mainly due to lower-than-expected service revenue and higher sales & marketing expenses. Note that the normalized net loss was derived after removing Rp315b unrealized forex gain, Rp1.1b accelerated depreciation, Rp1.3b loss from capital lease, Rp96b severance payment and Rp235b of tax impact. On a reported basis, its net profit improved to Rp376b (vs. –Rp25b in FY15) as a result of the forex gain and a one-off gain from the sale of towers to Protelindo in 2Q16. In short, the group’s FY16 performance was mainly affected by the accelerated changing consumer behavior (substitution from legacy services to data) as well as distribution challenges, and brand & network perception gaps. KPI-wise, XL has failed to achieve its top-line target (of c.10% YoY) but managed to achieve its EBITDA margin target of high 30% despite the absolute annual growth rate coming in below expectation (-4% YoY vs. better than revenue growth guidance).

YoY, FY16 revenue dived by 7% to Rp21.4T, no thanks to the lower interconnect revenue (-26%, due to lower off-net traffic) coupled with a softer service revenue (-4% to Rp19.2T) 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 to 46.4m (vs. 42.0m a year ago) in FY16 with blended ARPU which improved marginally by Rp1k to Rp35k. Its smartphone users grew to 29.1m with 63% penetration rate as opposed to 42% a year ago. EBITDA, meanwhile, was lowered by 4% with margin improving by 100bps to 37.6% as a result of effective cost optimization initiatives (i.e. tower lease renewal savings).

QoQ, XL’s revenue was flat at Rp5.3T in 4Q16 but with lower EBITDA (- 8%) as a result of higher sales & marketing costs (to build awareness with the 3G U900 & 4G rollout) and salary & employee benefits (due to severance payments for staff).

Outlook. XL expects data monetization to be the key driver for its revenue growth in FY17 with an aim to perform in-line with the industry average (of high single-digit growth). Its EBITDA margin, meanwhile, is expected to stay at the high thirties in view of better products and customers mix. Meanwhile, the group also guided for a targeted capex of not more than Rp.7T in FY17 with key spending continued to focus on its 4G technology development. All in, we are less optimistic on the group’s outlook in FY17 in view of the rapid change in customer behavior as well as more effort needed to be in place to transform itself to a Data-driven business model. We conservatively expect the group to achieve 3.6% YoY revenue growth in FY17 with EBITDA margin of 36.1%.

Target price stayed at RM4.81. We are keeping our Axiata’s FY16E/17E earnings unchanged for now, pending the upcoming results release due on 23rd February. Having said that, the uninspiring XL’s report card may cap Axiata Group’s FY16 performance as the former contributed c.33% to the latter’s EBITDA as of 9M16. Maintain MARKET PERFORM with an unchanged TP of RM4.81 based on targeted FY17E EV/forward EBITDA of 6.6x, representing an unchanged -1.5x SD below its two-year mean.

Source: Kenanga Research - 2 Feb 2017