We reiterate our OVERWEIGHT call on the sector. The expanded coverage of 4G and the crystallisation of the 5G rollout will expedite the demand for telco services. Telcos’ earnings are resilient with telecommunications having evolved into a necessity of modern life. The telco sector could also be poised for a re-rating if the new government is to abandon the current single wholesale network (SWN) model for the 5G rollout or revise the existing terms to the advantage of the mobile network operators (MNOs). Our sector top picks are DIGI (OP; TP: RM4.69), MAXIS (OP; TP: RM4.59), TM (OP; TP: RM8.30) and OCK (OP; TP: RM0.95).

Earnings of telcos are resilient with telecommunications having evolved into a necessity of modern life. Digital applications for work or pleasure, such as short messaging, virtual meeting, electronic cash payment, e-hailing, online shopping and online food and grocery delivery have become entrenched in everyday life.

The demand for local mobile and broadband will be supported with the wider coverage at the end of Phase 1 of the Jendela initiative. Players like DIGI (OP; TP: RM4.69) look set to benefit from the wider coverage, reaching the remote corners of Malaysia and the return of migrant workers. Meanwhile, telco infrastructure providers OCK (OP; TP: RM0.95) and EDOTCO of AXIATA (OP; TP: RM3.96) ride on the massive spending on telco infrastructure both domestically and in the region.

Under Jendela, targets were set such as nine million premises with access to broadband, 100% internet coverage in populated areas and 100Mbps mobile broadband speed by 2025. Thus far, good progress has been made and certain interim targets have even been exceeded. As of 9M2022, its Phase 1 target of 7.5m premises (1H2022: 7.2m) had access to fibre broadband and 95.8% (vs. 2022 target of 96.9%) of populated areas had access to 4G coverage. Average mobile broadband speed had also increased to 52.48 Mbps (megabits per second), surpassing the original Phase 1 target of 35 Mbps. In enhancing overall digital infrastructure, 2.48m premises enjoyed fibre connectivity (1H2022: 2.24m), 36k stations upgraded to 4G technology (1H2022: 34k), 1.42k 4G towers built (1H2022: 1.33k) and 839 locations had satellite connectivity as of 3Q2022.

MAXIS (OP; TP: RM4.59) overachieved in terms of base stations upgrade at 113% followed by U Mobile at 112% and Celcom at 103%. MAXIS again exceeded its target for building new 4G towers at 103% while for broadband infrastructure network coverage TM (OP; TP: RM8.30) attained 78% of its 2022 targets followed by MAXIS at 19%.

In terms of 5G coverage, the target is to reach 40% population coverage (vs. 37% target) by end-2022. Thus far, 54% of 3.5k sites for 2022 have been completed with coverage areas that include the Klang Valley, Penang, Johor and Perak. Johor led the way with a 91% completion followed by Kuala Lumpur (76%) and Selangor (57%). Meanwhile, Digital Nasional Bhd (DNB) has set itself a target of 70% population coverage by end-2023 and 80% by June 2024.

Meanwhile, we believe the telco sector could also be poised for a re-rating if the new government is to abandon the current SWN model for the 5G rollout or revise the existing terms to the advantage of the MNOs. To recap, the monopolistic SWN model for the 5G rollout was the key culprit behind the sector’s de-rating over the last two years.

On the other hand, there may be concerns over more cuts in broadband rates with the Pakatan Harapan coalition leading a “unity” government after the 15th general election. Nevertheless, we see a low risk of this happening as after the steep cut in 2018, broadband package prices in Malaysia now average at USD33/month (from USD45 in 2017) or USD0.14/Mbps which fall within the range of USD31 to USD258/month in neighbouring countries (see Table 1).

Recall, TM, the leading provider of broadband services in Malaysia, lost as much as two thirds of its market value in five months after the country’s telecommunications regulator, the Malaysian Communications and Media Communication (MCMC), under the recommendation of then Minister of Communications and Multimedia Gobind Singh Deo, rolled out the Mandatory Standard on Access Pricing (MSAP), effecting a 43% reduction in the price of the limited fixed broadband package to RM79/month from RM130/month previously, while tripling the speed to 30 Mbps from 10 Mbps. Similarly, the unlimited package saw a 61% reduction to RM129, while doubling the speed to 100Mbps. TM suffered a 6% YoY decline in UNIFI ARPU in FY18 but this was mitigated by a 19% increase in subscribers propelled by the improved affordability of the service.

We raise our valuations for both DIGI and MAXIS as we increase our EV/EBITDA multiples by 11x (from 10x previously) to reflect the positive outlook on the 5G rollout and 4G coverage.

Our sector top picks are DIGI, MAXIS, TM and OCK.

We like DIGI as it is: i) now the new market leader in the mobile market with a combined market share of 43% on the heels of the merger with Celcom; ii) CELCOM’s key points are its network capacity with wider coverage while DIGI has in-depth coverage with an emphasis on urban areas. CELCOM’s 4G and 4G+ cover 96% and 90% of the population respectively while DIGI’s 4G and 4G+ are at 95% and 80%, iii) competitive pricing and attractive bundling to attract migrant and domestic customers; iv) superior EBITDA margins of both DIGI and CELCOM at 5−6ppts above the industry average of 41−42% and iv) Roll-out of 5G will boost subscribers given the absence of MAXIS in the early stage of rollout.

We are positive on MAXIS given: i) its strong branding and customer loyalty, especially in the premium segment; and ii) resilient demand for services as it is ahead of its competitors in terms of constructing new 4G towers, fiberisation of premises and upgrading of existing towers, thus boosting its B2B revenue as both corporates and SMEs continue to upgrade their digitalisation.

We like TM for: i) positive tailwinds on the digital space as its network coverage nationwide expanded; ii) market leader in the home broadband market; iii) ability to give competitive pricing and attractive bundling to attract customers; iv) higher wholesale demand given the expansion of 4G and 5G coverage; and iv) it being the preferred network infrastructure provider.

We favour OCK for: (i) the tremendous growth opportunities in the telco infrastructure space at home and regionally, (ii) it being well positioned to benefit from the Jendela initiative and 5G rollout in Malaysia, and (iii) its earnings stability and visibility with about 62% of its revenue being recurring from telco tower maintenance.

Source: Kenanga Research - 18 Jan 2023