Our NEUTRAL call on the telecommunication sector remains unchanged. While competition may be intensifying in the 2H, cut-throat price war is unlikely given that current package prices are already quite appealing. Meanwhile, the mobile players are set to face another spectrum bill ahead but we expect the gearing to remain relatively manageable. Foreign shareholding, on the other hand, appears relative stable for all the telcos, thus suggesting that the selling pressure may likely be at tail end. All in all, we make no changes to most of our telecom companies’ FY17-FY18 earnings estimates as well as their respective target prices. We continue to favour fixed-line over the mobile names under the current challenging times given that the latter’s earnings are set to be affected by the heightened competition and potential change in landscape post the spectrum re-farming exercise. Telekom Malaysia (MP, TP: RM7.10) remains as our favourite pick for big cap space while OCK (TP: RM1.05) is maintained as our preferred choice under the mid-cap telecom space despite their ratings being lowered to MARKET PERFORM as per our rating definition. Meanwhile, we maintain our MARKET PERFORM call in MAXIS (TP: RM5.85) and AXIATA (TP: RM4.70). Our DIGI rating, on the other hand, has been raised to MARKET PERFORM with an unchanged target price of RM4.86.

Mixed 1QCY17 results. The sector incumbents reported mixed 1QCY17 report cards where TM reported better-than-expected results (thanks to higher revenue, lower-than-expected OPEX as well as lesser forex fluctuation) while Axiata and Maxis’ performances were in-line with our expectations. The former was mainly underpinned by higher regional OpCos contribution but largely offset by the poor Celcom and XL performance while the latter continue to be supported by its decent service revenue growth. Digi’s result, on the other hand, came in below par due mainly to the weak prepaid business as a result of headwinds in the migrant market. Besides, OCK posted a decent 1Q17 set of results, thanks to its enlarged towerco assets and better margins.

Competition may be intensifying in the 2H. The activation of the newly allocated 900Mhz and 1800Mhz spectrums from 1-July could narrow the network-gap between the top-four celcos players (figure 1). With these new assigned spectrums, both Digi and U Mobile are able to provide much better network coverage and experience to their subscribers and lure new users thereafter. These could potentially spark another stiff competition ahead given that the big three celcos’ are finding ways to defend their subscribers’ market share, which has been reduced to 76.8% at end-CY16 (vs. 98% in 4Q11) as a result of the higher acceptance of U Mobile and other MVNO players. Having said that, we do not expect any cut-throat price war as the current package prices already quite attractive.

Impending spectrum bill. The 2016 re-farming saw operators paying RM500m/RM218m for a 5MHz pair in the 900/1800 MHz bands respectively, of which 44% of the fee are upfront with the remainder in the form of annual payments over 15 years. It is understood that the 2600 MHz and 2100 MHz bands are up for renewal in December 2017 and April 2018 while the 700MHz is also up for re-farming in 2018 post the DTT migration. By assuming operators are: (i) charged RM650m/RM196m/RM153m per 5MHz pair in the 700/2100/2600 MHz bands, (ii) allocated the equal size of the spectrum in the respective 700/2100/2600 MHz frequencies, and (iii) charged under the same payment structure, we estimated that each Celcos would need to pay an upfront fee of RM965m and RM82m for the annual payments over 15 years (figure 2). Balance sheet wise, we estimate the mobile operators’ (Maxis, Axiata and Digi) gearing levels are still remain relatively manageable after incorporating the incremental upfront spectrum payments (figure 3).

Foreign selling may likely be at the tail-end. The weakening of MYR (against the USD) coupled with an uninspiring earnings growth prospect as well as change in the industry landscaping followed by the spectrum re-farming exercise had led to foreigners downplaying Malaysia's telecommunications sector since CY15. Nevertheless, the foreign shareholding level appears relatively stable for all the incumbents during the first five-month of the year, thus suggesting that selling pressure from foreigners may likely be at the tail end (figure 4).

Strategy – still prefer fixed-line players overall. TM (MP, TP: RM7.10) 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 (MP, TP: RM1.05), on the other hand, remains our preferred 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. Our TM and OCK ratings, however, have lowered to MARKET PERFORM (from OUTPERFORM previously) as the potential upside is less than 10% as per our rating definition. We continue to downplay the mobile names due to their uninspiring outlook. Despite maintaining our target prices for MAXIS (MP, TP: RM5.85), and AXIATA (MP, TP: RM4.70), we have upgraded our DIGI call to MARKET PERFORM (from UNDERPERFORM previously, in view of the limited downside from here) with an unchanged target price of RM4.86.

Source: Kenanga Research - 6 Jul 2017