TM reported a pleasant positive earnings surprise in 1Q19, thanks to the effective cost rationalisation plan. Moving forward, the group is set to accelerate convergence and empower digital in line with its transformation that reinforces customer centricity. Post-review, we have raised our FY19- 20E NP by 39%-45%. Raise the stock rating to OUTPERFORM with a higher DCF-driven TP of RM3.95.

Exceptional strong quarter. 1Q19 core PATAMI of RM296m (182% YoY) came in way above expectations and accounted for 49% each of our and the street’s full-year estimate. The key positive variance on our end was mainly due to much lower-than-expected OPEX and the adoption of the MFRS 16. No dividend was announced, as expected.

YoY, 1Q19 revenue declined by 2% to RM2.8b, due to lower voice (-11% to RM674m, fewer traffic minutes and cumulative customers) and internet (-3% to RM1.0b, higher Streamyx churn partially offset by higher Unifi take-up) segments’ contribution, partially mitigated by an increase in Data revenue (+7% to RM666m, thanks to higher contribution from International Leased Data at TM Global) as well as higher customer projects at TM One. EBIT, meanwhile, surged 158% to RM505m, thanks to reduction in all OPEXs followed the active cost rationalization as well as the adoption of the MFRS 16. Stripping off the non-operational items (i.e. unrealized forex loss on international trade settlement), group’s normalized EBIT also more than double to RM513m vs. RM207m a year ago. QoQ, turnover softened by 10% while EBITDA enhanced by 16% as the cost rationalization under PIP yielding positive results, where OPEX/Revenue ratio has improved by 10.2pp to 82.7% in 1Q19.

Positive impact from the adoption of MFRS 16, where TM’s EBITDA has been increased by 10% (or RM97m) to RM1.06b in 1Q19 but with higher D&A (+RM39m to RM560m) and finance cost (+RM26m to RM74m). All in, the new accounting standard has led the group to record higher PATAMI of RM308m vs. RM284m under the pre-MFRS 16 standard.

Continued to transform into a “New TM” that reinforces customer centricity. While the market is expected to remain competitive, the Performance Improvement Programme 2019-2021 (PIP2019-2021) yield improved profitability for the group in 1Q19. Moving forward, TM is set to continue accelerate Convergence and empower Digital in line with its transformation that reinforces Customer Centricity. Over the next 3 year, TM will continue to focus on 3 strategic pillars – converged services (solidifying convergence position and vertical focus to serve industries going digital), simplification & digitalization (product rationalization as well as simplify process & digitalization), and lean & lower cost (focus on core business & cost optimization), with its integrated network infrastructure to bring a convergence digital lifestyle to all Malaysians.

Maintain FY19 KPIs, for now. Despite recorded a sturdy performance in 1Q19, TM is keeping its FY19 KPIs unchanged for now, where the group is aiming to achieve a low to mid-single digit revenue decline (due to softer voice, data and managed services) with normalized EBIT target similar to FY18 level (at c.RM1b). We, however, believe the KPI targets are too conservative in view of the sustainable cost reduction arise from the PIP. Having said that, the degree of the cost saving moving forward may not be extensive as 1Q19 given a typical higher cost reduction tend to be recorded during the initial stage of each cost rationalization program.

Raise FY19-20E PATAMI by 39%/45%, respectively, post reducing our OPEX assumptions to align with the latest trend. Key earnings assumptions for FY19/20E include: (i) Unifi/Streamyx ARPU of RM167/RM85 & RM151/RM80, (ii) Unifi subscribers’ net add of 85k/80k, and (iii) 18-20% capex/revenue ratio.

Upgraded to OP (vs. MP previously) with higher DCF-driven TP of RM3.95 (vs. RM3.10; WACC: 8.4%, TG: 1%), implied a 5.2x EV/fwd EBITDA (c.-1 S.D. below its 3-year mean). Downside risks to our call include: (i) unfavourable change in regulation, (ii) stiffer fixed broadband competition, and (iii) higher-than-expected OPEX.

Source: Kenanga Research - 31 May 2019