The earnings delivery (versus our expectations) of telcos under our coverage improved sequentially in 3QCY24, with 40%, 40%, and 20% exceeding, meeting and missing our projections. In 9MCY24, service revenue growth (+1.4%) for domestic mobile network operators (MNO) was primarily driven by MAXIS (OP; TP: RM3.80) enlarged subscriber base for both the postpaid and fiber segments. Meanwhile, core net profit for the sector expanded 14% YoY, mainly driven by AXIATA (OP; TP: RM2.60) due to higher data traffic at Indonesia and extension in useful life of Edotco's towers. QoQ mobile subscriber and ARPU trends remained stable, aligning with expectations such as: (i) prepaid ARPU held resilient despite subscriber erosion, and (ii) postpaid net adds remained strong, countering weaker ARPUs. However, signs of easing competition in the fixed segment emerged earlier than anticipated - as TM (OP; TP: RM7.53) ARPU and subscriber net adds rebounded sequentially in 3QFY24. We downgrade our sector recommendation to NEUTRAL (from OVERWEIGHT). We believe U Mobile's surprise victory in securing the second 5G network implies the current overhang facing the MNOs may potentially take longer to resolve. It could also introduce greater complexities for the leading MNOs.

Our sector top picks are CDB (OP; TP: RM3.82) and TM.

Mixed results versus expectations. Earnings delivery (versus our expectations) of telco companies under our coverage improved sequentially in 3QCY24, with 40%, 40%, and 20% exceeding, meeting and missing our projections, compared with 20%, 60%, and 20% respectively, three months ago (Exhibit 1).

Sluggish service revenue growth. In 9MCY24, service revenue growth (+1.4%) for domestic mobile network operators (MNO) was primarily driven by MAXIS' enlarged subscriber base for both the postpaid and fiber segments. This more than offset service revenue contraction at CDB, as its prepaid subscriber base contracted in 3QCY24 following a clean-up exercise that led to substantial net subscriber attrition. This exercise involved: (i) consolidation of users that owned dual SIMs for both Celcom and Digi plans, and (ii) strategic decision to reduce reliance on one-time rotational SIM users and focus on long-term customers. Meanwhile, revenue for fixed player TM declined slightly by 2% YoY, primarily due to softer demand for international voice services, driven by the growing adoption of online conferencing platforms.

Earnings expansion propelled by AXIATA's high growth markets. 9MCY24 core net profit for the sector expanded 14% YoY, mainly driven by: (i) AXIATA: uplifted by extension in useful life of Edotco's towers and higher data traffic at Indonesia, and (ii) CDB: boosted by reduced taxes and the completion of accelerated depreciation.

Prepaid ARPU resilient in spite of subscriber erosion. Prepaid ARPUs sustained their stable trends in 3QCY24, with CDB's ARPU holding steady at RM28 for the fourth consecutive quarter, while MAXIS' prepaid ARPU remained consistent at RM29 since 4QCY23. In our view, this suggests improved usage or a benign competitive environment, enabling prepaid ARPU to find its floor following the strategic shift by major MNOs towards postpaid customer acquisition.

On the flip side, CDB continued to see significant prepaid subscriber net attrition for the fourth consecutive quarter in 3QCY24. MAXIS also recorded a slight net subscriber loss of 3k, reversing its 100k net adds in 2QCY24. These trends indicate that prepaid-to-postpaid migration remains ongoing, albeit at a slower pace, as reflected in the resilience of prepaid ARPUs.Looking ahead, we anticipate a more stable prepaid subscriber base for CDB, supported by recent efforts to streamline its prepaid segment by eliminating casual subscribers and focus on acquiring loyal users.

Strong traction in postpaid subs remains, but weaker ARPUs persist. On the other hand, postpaid ARPU extended its sequential downtrend in 3QCY24, likely due to several factors, including: (i) users down trading to more affordable plans and handsets amidst inflationary pressures, and (ii) onboarding of new users on entry level plans. Evidently, after holding steady at RM63 for four consecutive quarters from 3QCY23 to 2QCY24, CDB's postpaid ARPU slipped to RM61 in 3QCY24. Meanwhile, MAXIS's postpaid ARPU continued to decline QoQ, reaching RM67 from its recent high of RM73 in 4QCY22. On the bright side, subscriber net adds remain strong for both key players in 3QCY24, possibly reflecting market expansion driven by the affordable entry-level plans.

A breather from competition in home broadband. In the fixed broadband segment, while competition persisted, it showed signs of easing in 3QFY24 as TM experienced relief and CDB maintained its traction. Specifically: (i) TM: sequential ARPU rebounded to RM130 (2QFY24: RM128), with net adds recovering significantly to 27k after a muted performance of 9k-11k in 1HFY24, and (ii) CDB: ARPU climbed to RM109 (2QFY24: RM103), continuing its uptrend, with net adds reaching a high of 18k in 3QFY24. On the other hand, MAXIS faced challenges, with its ARPU edging lower to RM109 (2QFY24: RM103) and net adds declining sharply to just 9k (2QFY24: 15k). This was attributed to the rationalization of discounts and rebates on MAXIS' home offerings.The sustained competition for home fiber subscribers likely reflects MNOs' ongoing strategies to attract and retain convergence customers, to ensure their long-term loyalty to bundled postpaid plans.

U Mobile's win amplifies uncertainties. We downgrade our sector recommendation to NEUTRAL (from OVERWEIGHT) due to recent developments where U Mobile was selected to implement the second 5G network. We had previously expected up to 1QCY25 for uncertainties surrounding the second 5G network to resolve, paving the way for a re-rating in valuations for the MNOs. However, this view no longer holds as U Mobile's surprise extends the uncertainty, and increases the likelihood that resolution will take longer. Key areas requiring clarifications include: (i) specific MNOs that will collaborate with U Mobile and terms of their partnerships, (ii) final ownership structure of DNB, (iii) revised terms of DNB's 10-year 5G access agreement with other MNOs after NW2 launches, (iv) coverage and timeline targets for NW2, and (v) state of NW1's financial and operational health. In essence, U Mobile's win has raised more questions and may potentially lead to a more convoluted outcome for the leading MNOs (i.e. CDB and MAXIS).

Growth lies in the fixed line space. On the other hand, for fixed line players, they are well positioned to capitalize on growing demand for managed wavelength and wholesale bandwidth services. This opportunity is driven by a surge in investments by global tech giants that have collectively pledged over USD16.5b for DC, cloud, and AI infrastructure in Malaysia. Digital assets owned by fixed line operators (eg. terrestrial fiber optics backhaul, network hubs, and submarine cables with landing stations) are essential to facilitate data transmission across these emerging infrastructures.

Our top picks for the sector remain TM and CDB.

We like TM on account of: (i) it being leveraged towards secular data growth on the back of current trends such as digital transformation, proliferation of internet of things (IoT), cloud services powered by generative AI, etc, (ii) it benefitting from upcoming JENDELA Phase 2 projects via roll-out and monetization opportunities, (iii) earnings accretion from development of new hyperscale data center, and (iv) higher demand for data transmission via its network of digital infrastructure that includes global submarine cables and domestic fiber optics backhaul.

We like CDB for the following reasons: - (i) merger synergies are expected to amount to NPV of RM8b over 5 years - emanating from network (RM5.5b), IT (RM1.1b) and others (RM1.4b), (ii) its robust average FCF yield of 7.3% in FY24-25 implies capacity to pay steady dividends, and (iii) its largest mobile subscriber base in Malaysia, translating to economies of scale.

Source: Kenanga Research - 3 Dec 2024