We downgrade our telecommunication sector’s rating to NEUTRAL in view of the current headwind in the fixed broadband segment and lacklustre earnings outlook in the mobile space. Besides, valuations still appear less appealing as compared to the regional peers; thus, suggesting that foreign interests may continue to remain lacklustre in the near term. All in, we made no changes to our Telcos’ earnings forecasts and target prices but downgrade DIGI (TP: RM4.90) and MAXIS (TP: RM6.05) to MARKET PERFORM following the recent run-up. DIGI is the preferred pick for the sector while OCK (OP, TP: RM0.800) is retained as our preferred choice under the mid-cap telecom space. We reiterate our MARKET PERFORM ratings on TM (TP: RM3.55), and AXIATA (TP: RM4.80).

Mixed performance. Both MAXIS and DIGI reported decent sets of results in 1H18 with core PATAMI of RM900m (-0.2% YoY) and RM770m (+5.2% YoY), respectively. Despite their service revenues coming under pressure on a year-on-year basis (MAXIS: RM4.0b (-3.7% YoY); DIGI: RM2.9b (-0.4% YoY), as a result of the weaker prepaid revenue (due to continued SIM consolidation and migration to Postpaid) coupled with the adoption of MFRS 15 accounting standard), both companies have managed to sustain or even enhance their normalised EBITDA (in absolute term) as a result of better operational efficiencies. AXIATA, on the other hand, reported a disappointing 1H18, mainly impacted by investments in new digital business; higher D&A charges and tax credit in the previous year. Besides, AXIATA also incurred RM3.4b non-cash impairment in 2Q18 post the de-recognition and reclassification of Idea from associate to simple investment. TM, on the other hand, posted 1H18 results that was below expectations due to higher-than-expected OPEX and effective tax. The absence of dividend in 2Q18 was also a negative surprise. OCK, meanwhile, posted a decent report card in 1H18 with regional contribution continuing to climb despite some slowdown in the local segment. We continue to like OCK for its attractive growth prospects and growing recurring revenue stream.

The Internet – basic rights for all Malaysians. The authority has highlighted its intentions earlier to treat the Internet as one of the basic rights for all Malaysians through the National Connectivity Plan, which set to increase internet access throughout the nation via a combination of fibre-optic and wireless connectivity. Three key priorities' tasks have been identified by the government (under its broadband agenda), namely speed, affordability and coverage, of which the first two missions carried more weights than the latter for now. The move is expected to open up more fixed broadband competition where Tenaga National Bhd has lately decided to join the party. On the wireless connectivity front, we reckon the authority will encourage more active network sharing within the industry and to leverage on the operators’ current 3G/4G networks, especially in the rural areas. Besides, we also do not discount that the government may aspire to speed up investment in 5G once the international spectrum framework is cloudless.

Broadband battle. In response to the government’s agenda to cut broadband prices by 25% by year-end following the review of the Mandatory Standard of Access Pricing, all the fixed broadband service providers have reduced their respective broadband package prices. The introduction of Maxis’ RM89/month (at half the previous gross price) unlimited 30Mbps plan has triggered some fretfulness among the fixed broadband players. TM has subsequently made its RM79/month 30Mbps plan (which was initially only available for less than the RM4,500 income group) available to all subscribers but still maintaining its 60GB quota. TIME, meanwhile, also offers RM20-50/month discounts on top of the existing plans. Besides, all the players are also battling each other in their respective 100Mbps fibre broadband plan and have lowered their price tag to RM129/month but only TIME is able to offer symmetrical speeds for both download and upload. Despite escalating competition in the fixed broadband segment, we believe the current package prices are competitive enough and able to achieve the government’s agenda. The likelihood of a full-blown price war is low at this juncture, in our view, as the industry players will still aim to preserve their margins. On the mobile broadband front, in view of the current basic broadband offers are already at the affordable level powered by the latest 4G technologies coupled with an extensive network coverage, we reckon the authority will not be harsh to the mobile players from the affordability perspective.

Premium valuations against the regional peers. The local telecom operators’ share prices have continued underperforming the FBMKLCI since mid-2017 with YTD losses of 16%. Despite the persistently dwindling share price performance, the local incumbents’ valuations have yet to fall into appealing level and are still trading above the regional peers. Average forward PERs of 24x, 9.4x EV/EBITDA and 3.9% dividend yield are still above the regional peers’ average of 21.6x, 7.5x and 4.3%, respectively; thus, suggesting that foreign interests may continue to remain lacklustre in the near term.

Downgraded to NEUTRAL. In view of the current headwind in the fixed broadband segment, pedestrian earnings outlook in the mobile space coupled with relatively moderate valuations vs. the regional peers, we are getting less sanguine on the sector’s prospect moving forward. While we made no changes to all our telecom companies’ FY18-19E earnings and their respective target prices, we have downgraded our sector’s call to NEUTRAL (vs. OVERWEIGHT previously). DIGI (TP: RM4.90 but rating lowered to MARKET PERFORM (vs. OUTPERFORM previously) after the recent share price run-up) is our relative preference pick for the sector while OCK (OP, TP: RM0.800) remains our preferred choice in the mid-cap segment 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. Our MAXIS’ rating, meanwhile, is lowered to MARKET PERFORM (vs. OUTPERFORM previously) after the recent share price rally) with unchanged TP at RM6.05. Maintain MARKET PERFORM calls on TM (TP: RM3.55) and AXIATA (TP: RM4.80).

Source: Kenanga Research - 4 Oct 2018