1Q18 results came in within expectations, underpinned by higher data and solid postpaid revenue. DIGI is maintaining its FY18 guidance despite still challenging market conditions. Post review, we maintain our DCF-driven TP at RM4.90 (WACC: 6.3%, TG: 1.5%) but raised rating to OUTPERFORM.

Within expectations. 1Q18 PATAMI of RM386m (+3.5% YoY) came in within expectations at 26%/27% of house/consensus’ full-year estimates. The higher YoY performance was mainly underpinned by: (i) the better postpaid business (9.4% YoY increase in service revenue to RM569m) as a result of continued traction from prepaid to postpaid conversions, and (ii) higher EBITDA margin as a result of efficient cost management. Note that, DIGI has adopted MFRS 15 and 9 accounting principles in 1Q18. Stripping off the MFRS 15 impact, PATAMI is lower by 5.7% YoY to RM352m. As expected, it declared a first interim tax-exempt dividend of 4.9 sen (vs. 1Q17: 4.7 sen), translating to a payout ratio of 98.7%.

New accounting principles. With effective from 1 January 2018, DIGI has adopted MFRS 15 Revenue From Contracts With Customers using a modified retrospective approach (where the sale of device bundles with discounts will be affected by the timing of revenue recognition). Post MFRS 15’s impacts to 1Q18 income statement are as follows; (i) reduction in RM22m in service revenue, (ii) increase by RM58m in device revenue and RM2m in dealers & staff commission cost, and (iii) EPS uplift of 0.5 sen to 5.0 sen. The MFRS 9, meanwhile, will have an impact on the balance sheet in relation to the classification and measurement of financial asset and the impairment model.

YoY, 1Q18 service revenue declined by 0.8% to RM1.46b, mainly attributed to the weaker Prepaid segment (-6% as a result of continued levelling of legacy prepaid voice and messaging revenue). The dip, however, was partially cushioned by the higher Postpaid business (+9% to RM569m), mainly fuelled by its strong acquisitions and plan upgrades. EBITDA, meanwhile, improved by 9% to RM775 with margin firming to 47.4% (vs. 45.3% a year ago) on the back of an effective cost management. Stripping off the MFRS 15 impact, its service revenue was up by 0.7% (first YoY improvement since 2Q15) with EBITDA climbing 4.2% YoY, as a result of higher margin of 46.3%.

QoQ, 1Q18 service revenue weakened by 3.5% due to lower Prepaid (- 4.6%, impacted by the seasonal decline from a shorter number of days in 1Q) and Postpaid segments (-1.7%, mainly due to mobile termination rates revision). DIGI’s total subscriber base inched higher by 10k to 11.7m after attracting higher subscriber base in the Postpaid segment (91k (to 2.6m) but lost 81k net adds (to 9.2m) in the prepaid segment. The group's LTE/LTE-A population nationwide coverage has reached 88%/57% as compared to 87%/55% in 4Q17.

FY18 outlook. The group is aiming to pursue sustainable growth opportunities ahead with efficient operations and digital transformation. Although market conditions remain challenging, DIGI is maintaining its FY18 guidance with an aim to achieve: (i) flat-to-low single digit decline in service revenue growth, (ii) stable EBITDA (similar to FY17 level at c.RM2.9b), and (iii) capex to service revenue ratio of 10-12%. Note that the above guidance is based on the old accounting principles. All in, we expect the group to record service revenue YoY growth of -0.1%/-1.2% with EBITDA at RM2.9b/RM3.0b under the old/new accounting rules in FY18.

Upgraded to OUTPERFORM call (from MARKET PERFORM previously) with unchanged DCF-driven TP of RM4.90 as bargain hunting opportunities may emerge post the recent sell-down which could provide more than 10% upside from here. Besides, the likely Shariah reinstatement in May could also provide a near-term catalyst. Post result review, we have raised our FY18E/FY19E PATAMI by 0.4%/1.4%, largely on the back of higher revenue growth of 4.2%/3.4% (as a result of higher device revenue under the MFRS 15).

Source: Kenanga Research - 16 Apr 2018