We maintain our NEUTRAL call on the telecommunication sector. The potential merger between AXIATA and Telenor remains in the air with its due diligence process still ongoing. However, we still believe that its materialisation could benefit consumers and the overall market. In the meantime, we turn towards TM, whose share price saw traction with its strong 1Q19 results delivery. Interests could mount further assuming that the stock could be re-included as a benchmark KLCI constituent during the year-end review for 1H20, but the pending resolution for its broadband (Streamyx) woes could cloud near-term prospects. We downgrade AXIATA (TP: RM4.30) to UP (from MP) and TM (TP: RM3.95) to MP (from OP) on reflection of the stocks’ price movement against our TPs. At the meantime, we raise our TP for DIGI (MP) to RM4.70 (from RM4.55) on minor DCF adjustments from model housekeeping. DIGI remains as our preferred pick for the sector given its highest dividend yield (c.3%) and stable earnings.

1Q19 results snapshot. For celcos, DIGI and MAXIS performed as anticipated as lower subscriber counts drew lower earnings. However, AXIATA posted disappointing results owing to poorer-than-expected results from Celcom after stripping off gains from disposals and divestments. The fixed-line operator TM positively surprised, as in spite of declining internet and voice revenue, more efficient cost management propelled the solid core earnings growth (+181% YoY). In the meantime, towerco OCK broadly met our expectations in the face of much larger depreciation numbers from the sector-wide adoption of MFRS 16 (refer to overleaf for the adoption of MFRS 16 against KPI guidance for telcos).

Smaller players on the rise. Following the release of MCMC’s 2018 Annual Report and 1Q19 Facts and Figures, we gathered that the 3-leading celcos are jointly declining in their respective mobile subscriber market share (i.e. cumulatively at est. 70% as of 1Q19) likely owing to stiffer competition from other industry players. This is further aggravated by the declining prepaid and postpaid subscriber market size (refer to Appendix for details of market share). The rise of the underdogs could be attributed by their value-for-money propositions. Nonetheless, while the diminishing market appears to be moving at a flattish rate, the incumbent celcos seek to sustain profits through various cost-cutting measures and introduce new efficiencies.

Buzzing on Axiata-Telenor. According to the statistics provided during the announcement of the potential merger, AXIATA disclosed that the MergedCo could have a revenue market share of 35% and a customer market share of 48% (refer to Appendix for details of Axiata-Telenor MergedCo – Estimated Market Share and Position). Pursuant to the announcement of the potential merger between AXIATA and the Telenor group, the MCMC released its guidelines on mergers and acquisitions (M&A) on 17 May 2019. We highlight that the guidelines view a post-M&A market share of 40% and above to potentially “raise competition issues” and could be subject to assessment by the MCMC. Regardless, it is likely that the merits of the proposed merger would justify its approval. Such merits include: (i) more creation of local jobs to facilitate the expanded structure, (ii) better use of infrastructure to boost public connectivity, and (iii) more robust product offerings in the long run with the new capabilities. Currently, the merger is still at its proposal stage with the results of its due diligence likely to deliver results closer towards 4Q19. On this, we believe that Celcom (AXIATA) and Digi (Telenor) could slow down in offering updated products and packages until further details on the merger have been ironed out, possibly leading to a smoother competitive environment. The indicative share ownership ratio of the MergedCo is 56.6% to be held by Telenor and 43.5% by AXIATA. Though, this could change following the completion of the due diligence exercise.

Putting TM in the limelight. Though TM’s share price took a plunge following its exclusion from the benchmark KLCI in Dec 2018, the stock had regained some interest thanks to the fruits of its cost rationalisation initiatives. Granted that the group expects to maintain its more efficient business operations, we do not think that it is farfetched to expect the stock to regain its position as a KLCI constituent during the Dec 2019 review. While this may raise interest for the stock, ongoing concerns about poor coverage and service delivery of Streamyx may impede some sense of optimism. To address the limitation of copper cables in transmitting high bandwidths, we believe that TM could either resolute to (i) phasing off the Streamyx product in favour of wireless broadband, or (ii) investing in expanding its fibre footprint. However, either of which could potentially cloud near-term prospects owing the financial commitments required to execute these options. For now, we keep our DCF-driven TP for TM of RM3.95, downgrading the stock to MP (from OP) following the price rally post-1Q19 results.

Maintain NEUTRAL. Besides TM, we also downgrade AXIATA (TP: RM4.30) to UP (from MP) given the surge in investor sentiment from news of the MergedCo’s proposal. We believe that market could be reacting in anticipation of the higher synergies to be offered, but we believe it could be preemptive given the lack of further details at present. Sector-wide, cost rationalisation continues to be at the forefront of the telco players’ initiatives against the persistent and increasing stiff competitiveness in the market. Celcos may also see further recalibration to their guidance and strategies with the pending 700Mhz spectrum award. At present, we believe there could be a lack of value-buying opportunities in the large-cap space from the recent rally. At the meantime, we raise our TP for DIGI (MP) to RM4.70 (from RM4.55) on minor DCF adjustments from model housekeeping. DIGI remains as our preferred pick for the sector given its highest dividend yield (c.4%) and stable earnings.

The adoption of MFRS 16 – Leases expand on the recognition of finance leases and operating leases on the grounds that they provide “right-of-use” to the lease and should incur depreciation and interest charges. At the moment, FY19 guidances by telco operators remain unchanged at their respective pre/post-MFRS 16 levels. We present both points-of-view, where it appears that DIGI could potentially deviate from its FY19 EBITDA KPI while AXIATA, MAXIS and TM are within. Nonetheless, it could still be too soon to say if the targets are on track or if guidances would need to be revised, given that only 3M19 results are available.

Source: Kenanga Research - 3 Jul 2019