We reiterate our NEUTRAL call on the telecommunication sector as the muted earnings outlook and heightened competition landscape could potentially be neutralised by the impending M&As as well as index weighting position (due to large cap, liquid & Shariah-compliance sector status). We believe the sector is likely to trade sideways and mirror the prior year’s performance, under normal circumstance. We make no changes to most of our telecom companies’ FY17-FY18 earnings estimates as well as their respective DCF-based target prices. We continue to favour the fixed-line player over mobile names under the current challenging time given that the latter’s earnings are set to be affected by the heightened competition. On top of that, the upcoming spectrum re-farming and any potential corporate exercise are also expected to change the mobile landscape in the long-term. Telekom Malaysia (OP, TP: RM7.03) remains as our favourite pick for big cap space while OCK (OP, TP: RM0.96) is maintained as our preferred choice under the midcap telecom space. Meanwhile, we maintain our MARKET PERFORM calls in both MAXIS (TP: RM6.20) and DIGI (TP: RM4.98) but raise AXIATA’s SoP-driven target price higher to RM4.78 after re-accessing its stake in M1. Digi remains our preferred choice for consistency play (supported by its agile execution capability and high dividend yield of >4%) while AXIATA will be a better pick for a rebound theme.

2017 – likely to mirror prior year’s performance but… We believe the local incumbents could potentially be trapped in a range-bound and mirror the prior year’s performance, barring any unforeseen circumstances, in 2017 in view of the comparable earnings' guidance provided by all players as well as the challenges facing the industry. Based on our recent PER study, TM and MAXIS appear to have the greatest upside while AXIATA is currently trading at high PER range. For DIGI, meanwhile, its upside appears limited from here. Having said that, while both companies (TM and AXIATA) have deemed the potential merger news is speculative, trading sentiment could potentially be lifted should any solid discussion being developed in the future.

Muted earnings outlook. The recent release of the industry incumbents’ FY17 KPIs (where most of the mobile players are expecting relatively flattish service revenue and EBITDA annual growth rates, a similar growth pace as in FY16) suggested that any opportunity on the top-line could be largely offset by the costly customer acquisition (i.e. elevated marketing/network expenses as a result of the heightened competition) and weak consumer sentiment. Data segment remains the key growth area where Celcos continued to spend heavily and strengthen their network coverage to capture opportunities from the growing internet demand. While the current competition landscape appears somehow stable for now, the race, however, is expected to be elevated in 2H17 after the full implementation of the 900/1800MHz spectrums. TM, meanwhile, is expecting a slightly higher top-line annual growth of 3.5-4.0% (vs. targeted 3-3.5% in FY16) with EBIT maintained at FY16 level (at c.RM1.52b). The EBIT margin pressure is expected to come from Webe as well as the HSBB2 and SUBB project rollouts.

Key events slated for the year include: (i) potential spectrum re-allocation of the 700 (upon completion of the digitalization and migration of current broadcast operators), 2300 and 2600 MHz spectrum bandwidths (which are due for renewal in CY17), and (ii) intensified mobile network battle in 2H17. Besides, with increasing operational costs, spectrum scarcity and escalated data demand, operators may need to consider collaboration to widen the network sharing, business process outsourcing, as well as to complement their connectivity value proposition with more digital contents. In addition, consolidation among the industry’s players could potentially be triggered should operators strive for more efficiencies, particularly in areas such as networks and customer acquisitions.

Strategy – still prefer the fixed-line player overall. TM (OP, TP: RM7.03) remains as our favourite big cap pick for the sector given: (i) less competition in its fixed-line broadband business, and (ii) its inroad to become a convergence champion. OCK (OP, TP: RM0.96), on the other hand, remains as our top pick for the mid-cap telecom in view of: (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 expanding EBITDA margin trend. We continue to downplay the mobile names due to their uninspiring outlook. Despite maintaining our DCF-driven target prices for both MAXIS (MP, TP: RM6.20) and DIGI (MP, TP: RM4.98), we have revised our AXIATA’s SoPdriven target price higher to RM4.78 (from RM4.64 previously) after re-accessing its stake in M1 but continue to rate is UNDERPERFORM as we believe the group may face another tough year ahead as a result of heightened competition, tax and regulatory uncertainties in its key OpCos.

Source: Kenanga Research - 29 Mar 2017