We are raising our telecommunication sector’s rating to OVERWEIGHT (vs. NEUTRAL previously) after the recent sharp sell-down which could be a great bargain hunting opportunity for investors. Despite muted earnings' outlook and heightened competitive landscape, the incumbents could be continued to benefit from their index weighting position (on factors such as large capitalisation, liquid shares and Shariah-compliance sector status). Furthermore, the potential listing of edotco and U Mobile could also provide a much-needed excitement to the sector. All in, we made no changes to our Telcos’ earnings forecasts and target prices but raised MAXIS, and AXIATA to OUTPERFORM following the recent sell-down. DIGI (OP, TP: RM4.90) is our favourite pick for big cap while OCK (OP, TP: RM0.850) is retained as our preferred choice under the mid-cap telecom space. TM (OP, TP: RM4.00) with AXIATA (TP: RM5.15) ideal for traders who prefer higher volatility, while MAXIS (TP: RM6.05) could be a preferred choice for range traders.

Moderate 1Q18 Performance. The sector incumbents reported moderate 1QCY18 report cards with two (AXIATA and TM) out of five companies coming in below expectations. None of the companies beat expectations during the said quarter. With the implementation of MFRS 9 and 15 accounting policies since beginning of the year, all the mobile incumbents have seen an adverse impact on their respective service revenue (where the sale of device bundles with discount affected by the timing of revenue recognition) but with a muted impact at the EBITDA level. While MAXIA and DIGI’s results came in with no surprises, AXIATA delivered a weak report card in 1Q18 due to higher-than-expected OPEX and widening Idea’s losses. Both AXIATA and DIGI kept their respective 2018 KPIs largely unchanged while MAXIS had revised its service revenue and EBITDA guidance lower to reflect the changes in the accounting treatment under MFRS 15. On the fixed-line front, TM delivered a poor set of result in 1Q18, mainly owing to lower-than-expected turnover as well as higher-than-expected OPEX and effective tax rate. While management is keeping its FY18 guidance, the tepid 1Q18 performance is likely to keep KPIs in check. OCK, on the other hand, posted a decent report card in 1Q18 with regional contribution continuing to climb despite some slowdown in the local segment as a result of the cautious spending pre GE-14.

Foreign selling may likely be at the tail-end? The weakening of MYR (against the USD) coupled with uninspiring earnings growth prospect as well as change in the industry landscape followed by the various spectrum re-farming exercises had led to foreign funds downplaying Malaysia's telecommunications sector since CY15. Besides, policy uncertainties post the recent change in government also triggered foreign funds to review their portfolio allocation in the Malaysian equity market. Nevertheless, the foreign shareholding level appears to have stabilised since March 2018 (indeed, there was no extensive foreign selling after GE-14); thus, suggesting that selling pressure from foreigners may likely be at the tail end.

Affordable broadband services ahead. To align with the Government broadband initiatives, TM is set to introduce several broadband plans in the coming months. Top of the list is an affordable entry level Unifi@30Mbps plan to ease the burden for targeted B40 segment of the population. Besides, the group is also set to offer internet speed that is twice faster than currently available at no extra cost under the new Unifi ‘turbo’ plans. While TM is set to unveil the details next week, the real challenge to the group is to maintain its network quality with growing coverage. The broadband initiatives, nonetheless, may not be limited to just wired connection, in our view. Should the mobile incumbents also take the same initiative, the impact, however, is expected to be less severe as compared to the fixed-line operators as more than 90% of the country already has access to the 4G network at more affordable prices. The real challenge for the mobile operators is to enhance and optimise network quality, especially in the rural areas. Perhaps the upcoming 700MHz spectrum allocation could help to ease the challenge, at least partially.

Valuations are comparable with the regional peers. The local telecom operators’ share prices have continued underperforming the FBMKLCI since mid-2017 with YTD losses of 18%. The persistence dwindling share price performance has led the local telecom operators’ valuations lower to a more appealing level. Average forward PERs of 23-21x, 8.6-8.6x EV/EBITDA coupled with a decent dividend yield of 4.1-4.4% for FY18-19 are not far off compared to regional peers’ valuations; thus, suggesting that value could emerge from here.

Bargain hunting opportunities emerge post the recent sell-down. While we made no changes to all our telecom companies’ FY18-19E earnings as well as their respective target prices, we have revised our MAXIS, and AXIATA’s ratings to OUTPERFORM (vs. MARKET PERFORM previously) following the recent sell-down, which we believe the current level could provide great bargain hunting opportunities. Our top pick is DIGI (OP, TP: RM4.90) due to its relatively resilience earnings and decent dividend yield. Besides, we continue to favour OCK (OP, TP: RM0.850) 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. For traders, who prefer higher volatility, TM (OP, TP: RM4.00) and AXIATA (TP: RM5.15) are better picks while MAXIS (TP: RM6.05) could be a preferred choice for range trading players. Note that, we have raised our TM’s target price to RM4.00 (vs. RM3.70 previously, please refer to today TM’s company upate report (titled Affordable Broadband For All) for details) given its better-than-expected broadband price cuts and earnings impact. We believe the recent sharp share price correction on TM has been overdone, thus providing great bargain hunting opportunities.

Source: Kenanga Research - 4 Jul 2018