We are keeping our NEUTRAL call on the telecommunication sector. We believe the current uncertainties in policy would continue to keep investors at bay for the sector in 1Q19 but expect the operational environment to improve in the 2Q/3Q19 should the authority manage to conclude the National Fiber and Connectivity Plan (NFCP). Our recent M&A study on the regional telecommunication sector on targeted multipliers suggested that MAXIS and DIGI are traded at their fair values while AXIATA, TM and OCK’s valuations may have room for expansion. All in, we made no changes to our Telcos’ earnings forecasts and target prices (except OCK, where we have lowered our target price to RM0.570 with an unchanged OUTPERFORM rating). AXIATA (OP, TP: RM4.60) and OCK (OP, TP: RM0.570) are our preferred picks for the big/mid-cap telecom space.

3Q18 results snapshot. All the mobile incumbents posted decent set of 9M18 results with no major earnings surprises. The aggregate top-3 mobile incumbents’ total revenue remained flat QoQ (to RM5.68b) with service revenue inching higher marginally by 0.2% QoQ to RM4.98b, thanks to better performance from MAXIS and CELCOM. On the fixed-line segment front, while TM posted a better-than-expected operational performance in 3Q18, its PATAMI slipped into the red after recording a one-off impairment loss on network assets. The group also revised its dividend policy in view of the challenges in operational environment.

Moving towards to the digital economy. The government has allocated RM1b to further develop fibre optic infrastructure and to ensure effective distribution of the spectrum throughout Malaysia under the Budget 2019. While MCMC has yet to announce the detailed work plan under the National Fiber and Connectivity Plan (NFCP), we understand that the authority has the intention to focus on 17 key ambitions categorised under the 4 initiatives, namely: (i) ensure optimum deployment of digital infrastructure, (ii) provision of affordable services and improve the quality to drive the digital economy, (iii) promote competition, and (iv) increase participation in the digital economy, based on the recent draft proposal.

Inroad in nationalising the telecommunication network infrastructures? The authority also highlighted that one of the key challenges in the NFCP implementation is to ensure buy-in from stakeholders to roll out infrastructure as public utility in the recent draft NFCP. While further clarifications and discussions are required on the above statement, we do not discount that the government may have the intention to nationalise the telecommunication infrastructures in order to speed up the country’s digitalisation process. Should the intention materialise, the sector’s incumbents (especially TM) could potentially unload a large part of their future capex requirement, especially in fiberizing their network assets. Having said that, the source of funding as well as the structure of the proposed scheme would be vital factors to determine the success of the nationalisation plan, if any.

Fair values range from the Merger & Acquisitions (M&As) perspective. While there is no solid corporate exercises discussion among the players thus far, we would not be surprised should the incumbents consider this route judging from the current challenging industry outlook. Our recent M&A study on the telecommunication sector suggested that the current prices of MAXIS and DIGI are already traded at fair value while AXIATA, TM and OCK may have rooms for upside.

What to expect in the year 2019. We believe the policies uncertainty coupled with the upcoming 700MHz spectrum reallocation will continue to pose a great challenge to the telecommunication sector in 1Q19 and may keep investors at bay. Nevertheless, the operational environment is expected to be improve in 2Q/3Q19 should the government manage to conclude the NFCP. Despite TM’s (MP, TP: RM2.50) operational environment remaining cloudy over the short-to-medium term, it would be an interesting stock to watch in 2019 and could have a positive re-rating catalyst should the government decided to nationalise the communication infrastructure as public utility. The move is expected to ease TM’s capex concern and transform the group into a pure service provider (from an infrastructure cum service provider currently), which in turn could reduce the group’s regulatory risk and uncertainties ahead.

Maintain NETURAL rating. We make no changes to all our telecom companies’ earnings forecasts. AXIATA (OP, TP: RM4.60) is our preferred pick for the sector (due to a stronger Celcom and earnings recovery at XL as well as on bargain-hunting opportunity that could potentially arise post the recent sharper-than-expected decline in share price) while TM (MP, TP: RM2.50) may be an interesting stock to watch in 2019 should the regulatory and competition risks are reduced. We retained our MARKET PERFORM call on MAXIS (TP: RM5.55) and DIGI (TP: RM4.65). Our OCK’s target price, however, is reduced to RM0.570 (vs. RM0.750 previously) after raising our WACC assumption to account for the prolonged de-rating process in the local telecommunication sector. Besides, the persistence selling pressure arising from the heightening risk of losing its Shariah compliance status in 1H19 could continue to cap the share price performance over the near term. Our OCK’s target price of RM0.570 implied a forward PER of 19.8x, which is in line with the average targeted M&A multiplier in the Asia Pacific (Emerging) market. Despite a lower target price, we are keeping our OUTPERFORM call unchanged as the stock could still be able to provide a potential capital upside of 32% from here. We continue to favour OCK 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.

Source: Kenanga Research - 3 Jan 2019