We maintained our NEUTRAL view on the telecommunication sector as the muted earnings outlook and heightened competitive landscape could potentially be neutralised by the index weighting position (due to large cap, liquid & Shariah-compliance sector status) and market excitement from potential listing of edotco and U Mobile as well as M&A activities. The industry incumbents are set to continue expediting their digital transformation as well as enhancing their operational efficiencies in CY18. Besides, our recent study on the global key listed towercos suggested that Asia towercos tend to have higher financial leverage, PATAMI margin and ROE but lower PER as compared to the listed peers in the CALA and EUROPE region. All in, we made no changes to our Telco earnings forecasts and target prices. We continue to favour fixed-line over the mobile names with Telekom Malaysia (TM, OP, TP: RM6.85) remaining as our favourite pick for big cap while OCK (OP, TP: RM0.950) is retained as our preferred choice under the mid-cap telecom space. Meanwhile, while we maintain our MARKET PERFORM call for AXIATA (TP: RM5.35) and DIGI (TP: RM4.90), we have lowered MAXIS (TP: RM6.10) to MARKET PERFORM given that its share price had performed since our last upgrade and is providing less than 10% total return from here.

Muted earnings outlook. The sector incumbents are set to report a similar performance in 2018 as in prior year in view of the comparable earings’ guidance provided by all players as well as the challenges facing the industry. Service revenue growth of the mobile players are expected to flat or negative (largely due to the continued SIM consolidation; new access pricing structure; and challenges in its OpCos (for Axiata)) in FY18 with margins likely to stay similar to the prior year. On the fixed operator front, TM is targeting annual revenue growth of 3.5-4% (underpinned by its complete quad play services) with normalized EBIT maintained at FY17 level (at c.RM1.2b). Moving forward, all the industry incumbents are set to continue expediting their digital transformation as well as enhancing their operational efficiencies. While we concur with the industry players’ initiatives, we believe the sector will continue to remain stagnant while waiting for the next growth opportunity to arise. Besides, with increasing operational costs, spectrum scarcity and increased data demand, operators will need to work around the connectivity challenges with industry peers to sustain financial performance. Thus, we do not discount operators finding ways to strive for more efficiency gains via network collaboration/optimisation and/or lower customer acquisition costs.

What we expect in 2018? We expect mobile service revenue to see a mild dip (-0.8% YoY) in CY18 due to the prolonged industry-wide SIM consolidation, new access pricing structure and competitive pressure in the IDD segment. EBITDA margin, however, is likely to remain relatively stable, similar to the prior year as a result of the effective cost optimisation efforts. Competition, on the other hand, is expected to stay with key battle likely to focus on the prepaid segment, product upselling, and data monetisation. Besides, capex is set to remain elevated due to spectrum-related costs for 700MHz (where the result of the tender process is likely to be announced in mid-2018), and continued network expansion. U Mobile, Unifi mobile and other MVNO players are likely to continue gaining subscriber market share as the big-3 incumbents tend to focus on acquiring revenue-generating subscribers, thus leaving the price-sensitive sub-segments to the smaller operators. Any excitement from the sector is expected to come from: (i) potential listing of edotco and U Mobile, and (ii) M&A activities.

Tower studies. Our recent study on the global key listed towercos study suggested that; (i) a pure towerco’s EBITDA margin is likely to be within the range of 50-60%, and (ii) Asia towercos tend to have a higher forward (a) financial leverage, (b) PATAMI margin (which we believe could be partially due to favourable interest and taxation rate environment), and (c) ROE (as a result of better PATAMI margin) as compared to peers in the CALA (Central and Latin America) and EUROPE regions. Nevertheless, Asia towercos’ forward PER ratio tend to be lower as EBITDA/site is less compelling (which we believe could be due to higher number of roof-top towers vs. monopoles) as compared to other regional peers. In addition, we also downplay the likelihood of edotco and OCK listing their tower assets under the REIT structure in view of the limitation of the financial leverage (where REIT companies typically have low gearing ratio of <1x, thus constrainting the towercos from expanding their tower portfolio further) and land ownership issue (where towercos tend to lease rather than acquire the land for their towers).

Still prefer fixed-line player overall due to relatively lower competition in the fixed-line space. TM (OP, TP: RM6.85) remains as our favourite pick for the big cap due to: (i) its long-term growth opportunities arising from its increasingly widening broadband and network coverage, (ii) less competition in its fixed-line broadband business, and (iii) its laggard performance YTD, which could provide room for the stock to play catch-up when trading sentiment improves. Besides, we continue to favour OCK (OP, TP: RM0.950) under the mid-cap telecom in view of its: (i) healthy cash flow on the back of escalating recurring income trend, (ii) ability to ride with the passive infrastructure sharing trend, and (iii) expanding EBITDA margin trend. Meanwhile, while we made no changes on our MARKET PERFORM calls on AXIATA (TP: RM5.35) and DIGI (TP: RM4.90), we have lowered MAXIS to MARKET PERFORM (from OUTPERFORM previously) with unchanged TP of RM6.10 given that its share price has improved 3% within a week (since our last upgrade on 16-March), lowering the potential total return to <10% from here. All in, we are keeping our NEUTRAL view on the sector due to stiffer competition and data monetisation challenges. The sector is currently trading at 10.4x EV/EBITDA in FY18, at a 122.3% premium as compared to the regional average of 8.5x. We expect modest performance for all the telecom stocks in 2018, supported by the decent dividend yield of 3.4%.

Source: Kenanga Research - 5 Apr 2018