Post a company visit, we came away feeling reassured by DIGI’s near-term prospects. Efforts are in place to drive a larger internet and postpaid users proportion. Near-term operations could benefit from expedited network deployment and capacity upgrades from heavy front-loaded capex in 1H19. Maintain MARKET PERFORM and DCFdriven TP of RM4.70 (WACC: 7.2%, TG: 1.5%).

A healthier mix. Based on the recent 2Q19 results, the group’s total subscribers stood at c.11.36m (vs 2Q18 of c.11.66m), with a postpaid:prepaid mix of 26%:74% (vs 2Q18: 23%:77%). The growing postpaid proportion was led by revamped programmes for easy device ownership (i.e. Phone Freedom 365) and entry level postpaid plans which drew a share of prepaid customers over. While the decline in prepaid subscribers was mainly led by recalibration of subscriber base in 1Q19 (to reduce the dependency on legacy voice revenues), more prepaid subscribers are leaning towards internet-based plans, which offer less-hassle customer experience.

Overall, ARPU for the segments have slightly diminished at RM70/postpaid user (vs 2Q18: RM72) and RM29/prepaid user (vs 2Q18: RM32) which we believe is due to more competitive pricing and a greater preference for more affordable packages. On the revised guidance for a single-digit decline in 2019 service revenue, we view this to be led by the lower base of prepaid customer post-1Q19.

Lean and clean. Against other players in the market, DIGI is seen leading in terms of operational efficiency with a 1Q-2Q19 post-MFRS 16 EBITDA margins of 53-54% (closest peer Maxis was at 49% in 1Q19). The group’s streamlined operating structure is backed by efficient network coverage and capacity expansion initiatives, while a sustainable business structure is supported by a lean workforce. We expect DIGI to continue to be at the forefront in terms of margins and operating efficiency, hence we are not too alarmed by the revised low single-digit decline guidance in 2019 EBITDA, as the slightly weaker performance is in part of the lower top-line for the year.

Not pulling back any punches. Amidst the ongoing due diligence on the planned merger between Telenor Asia and AXIATA (UP, TP: RM4.30), we take comfort in knowing that it is not disruptive towards the overall business operations of the group. Going ahead with its capex plans, the group had invested towards further capacity upgrades and fibre network expansion, the deployment of Network Function Virtualisation and to boost its LTE-A network coverage to 70% of population. Additionally, while being a relative newcomer into the space, DIGI looks to tap into the present opportunities in the SME/B2B market in providing business solutions.

Post company visit, we leave our FY19E/FY20E earnings unchanged.

Maintain MARKET PERFORM and DCF-driven TP of RM4.70. Our target price (based on WACC: 7.2%, TG: 1.5%) implies an EV/Fwd EBITDA of 12.0x/11.7x against our FY19E/FY20E earnings. Overall, DIGI remains a more compelling option in the telco space owing to its market leader position and highly efficient cost management, while commanding the highest dividend yield of 3.6% for FY19/FY20. However, trading valuations could be overly bullish at this moment, spearheaded by the planned merger.

Risks to our call include: (i) stronger/weaker-than-expected service revenue, (ii) stronger/weaker-than-expected OPEX, and (iii) stiffer competition.

Source: Kenanga Research - 25 Jul 2019