We reiterate our NEUTRAL stand on the telecommunication sector. Higher data segment contribution is expected to stabilise the industry’s service revenue growth in CY18 (after posting four consecutive year of decline). Apart from the on-going spectrum battle and industry-wide SIM consolidation, further excitement could potentially come from U Mobile, which is planning for an IPO after GE14. All in all, we made no changes to our telecom companies’ FY17-FY18 earnings estimates but revised their respective target prices after rolling over our valuation base-year to CY18. 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 (OP, TP: RM6.85) remains our favourite pick in the big cap space while OCK (TP: RM1.05) is maintained as our preferred choice under the mid-cap telecom space. Meanwhile, we maintain our MARKET PERFORM calls in MAXIS (TP: RM6.10); AXIATA (TP: RM5.15) and DIGI (TP: RM4.90).

No major hurdles. The sector incumbents reported reasonable 3QCY17 report cards that largely met expectations and shown some sequential operational improvements despite the operational and competition landscape remained challenging. Maxis’ 9M17 result came in above expectations, thanks to higher service revenue coupled with better margins while Digi and Axiata’s numbers came in without any surprise. TM, on the other hand, performed in-line with the street’s estimate but above ours due to lower-than-expected net finance costs. In addition, OCK’s 9M17 result was below expectation due to lower-than-expected Telecommunication Network Services segment contribution and higher administrative expenses. Despite the moderate 9M17 performance, the seasonally strong 4Q should drive the group to meet our full-year estimate.

Service revenue growth appears stabilising. While the Big 3 aggregate mobile service revenue is set to post the fourth consecutive year of decline in CY17 (-1.7% YoY to RM9.5b, as a result of the deteriorating voice and SMS revenue), the quarterly trends appeared to have stabilised after Celcom and Maxis continued to show mild sequential improvement since 2Q/3Q16, thanks to higher data-centric and upselling plans being introduced. Moving forward, in view of the rising data revenue contribution, we expect such positive quarterly trends to continue and record a mild 0.7% YoY growth in CY18.

Spectrums battle. Recall MCMC had outlined the 700MHz frequency band framework in last October which is open for applicants to submit their respective preliminary 5-year business plan (before 22nd January 2018) to perform the tender process. The proposed spectrum pricing was very reasonable, with total cost for a 5MHz pair in the 700MHz band at RM494m, slightly lower than the RM500m for the 900MHz band. Note that, there are a total of eight spectrum blocks available for tender which are valid for 15 years with effective from January 2019. All in, we believe all the key mobile players are likely to participate in view of the attractive pricing coupled with greater network coverage area (under the 700MHz frequency), which could lead to capex savings in 2018 and beyond. Meanwhile, we also understand that the soon-to-expire 2100 and 2600 MHz spectrum bands would be extended for two years, which could provide some breathing rooms for Cellcos to strengthen their balance sheet.

What to expect in the year 2018. While competition is expected to remain (and may potentially escalate should incumbents turn to a more aggressive mode), Cellcos are set to continue to focus on growing data revenue and striving for more operating efficiency. Apart from the on-going spectrum battle and industry-wide SIM consolidation, further limelight could potentially come from U Mobile as the group was reported to had turned EBITDA positive in CY17 with an aim to go for an IPO after GE14. On the fixed-line front, TM is set to focus on the retail fixed broadband segment and accelerate convergence as well as empower digitization to optimize processes and productivity.

Strategy – still prefer fixed-line players overall. While we made no changes to our telecom companies’ FY17E/FY18E earnings estimates, we have revised the target prices after rolling over our DCF valuation base year to CY18. Meanwhile, we also updated the forex assumptions as well as IDEA and M1’s latest share price under our Axiata’s Sum-Of-Parts valuation. TM (OP, TP: RM6.85 vs. RM6.75 previously) remains as our favourite big cap pick for the sector. We continue to rate MARKET PERFORM to all the Cellcos but raised their target prices - MAXIS (TP: RM6.10 vs. RM6.05 previously); AXIATA (TP: RM 5.15 vs. RM4.95) and DIGI (TP: RM4.90 vs. RM4.85). OCK (OP, TP: RM1.05 vs. RM1.00), 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.

Risks to our call include: (i) stronger-than-expected competition, (ii) regulatory/structural headwinds, and (iii) larger-than-expected capex. Potential industry consolidation is a key upside risk.

Source: Kenanga Research - 4 Jan 2018