DiGi’s 3Q13 results were slightly ahead of expectations, as higher-than-expected tax incentives boosted earnings. While the company is on track to meet its revenue growth guidance, management now expects some pressure on EBITDA margins. We tweak our FY13-14 earnings higher by 1-5% but leave our DCF valuation unchanged. The absence of tax incentives in FY14 will imply tepid earnings growth. Maintain SELL.

¨      Ahead of expectations. After adjusting for an accelerated depreciation of MYR153m,DiGi’s 9M13 core net profit of MYR1,270m (+5.7% y-o-y) was slightly ahead of our (76%) and consensus (77%) full-year estimates. The key variance was in the lower-than-expected effective tax rate due to higher-than-expected mobile broadband tax incentives.

¨      Showing improvements as expected. Q-o-q revenue growth rebounded to 2.8% (2Q13: +0.4%), partly driven by higher handset sales (+15.7%). Service revenue grew 1.8% q-o-q on the back of steady data (+3.5%) and voice (+0.9%) growth. Its 3Q13 EBITDA margin was relatively stable at 45.1% (2Q13: 45.2%), but core net profit rose 10.6% q-o-q to MYR458m boosted by a lower effective tax rate.

¨      Briefing highlights. Management maintains its 2013 revenue growth guidance of 5-7% but updated its EBITDA margin guidance – it now expects a 1ppt y-o-y dilution (FY12: 46.0%). The key reasons for the lower margin guidance were weakening international direct dial (IDD) margins and higher-than-expected handset sales. Q-o-q, DiGi’s effective tax rate was substantially lower at 16.7% (2Q13: 23.1%) and we believe it will likely enjoy the low effective tax rates similar to those in 4Q13. As its network modernisation is fully completed, it does not expect any further accelerated depreciation from 4Q13 onwards. Meanwhile, management is still exploring the potential of a business trust option, but is unable to reaffirm if its evaluation can be concluded by year-end.

¨      Dividends. DiGi declared the third interim net DPS of 5.7 sen, which translates into a payout ratio of 99%. This brings its YTD DPS to 14.3 sen. For FY13, we maintain our DPS forecast of 20 sen, assuming a 100% payout ratio.

Briefing highlights
Outlook. Management maintained its 2013 revenue growth guidance of 5-7%, which appears fairly comfortable now as 9M13 revenue grew 5.7%. This is quite consistent with our earlier view that the telco will likely only meet the lower end of its guidance unless voice usage picks up significantly and data growth improves sequentially. A positive takeaway from 3Q13 is that on a sequential basis, voice revenue continued to remain stable (+0.9%), while data revenue growth of 3.3% was relatively steady (2Q13: +3.4%).
We note, however, that management has updated its 2013 EBITDA margin guidance, and now expects a 1ppt y-o-y dilution (FY12: 46.0%). The key reasons for the lower margin guidance were weakening IDD margins and higher-than-expected handset sales. While management has completed its network modernisation programme, we understand that opex savings going forward will not likely materially lift EBITDA margins.

On a positive note, DiGi’s 3G population coverage of 76% (2Q13: 72%) as at 3Q13 exceeds its initial target of 75% by year-end. Its network quality continues to improve with greater stability for both voice and data, although usage trends have yet to see a positive inflection, in particular the postpaid segment. Nonetheless, DiGi is gaining good traction in capturing new postpaid subscribers.
Tax incentives. Q-o-q, DiGi’s effective tax rate was substantially lower at 16.7% (2Q13: 23.1%) due to mobile broadband tax incentives. 2013 is the final year that DiGi would enjoy these broadband network-related tax incentives. Although management did not offer specific guidance, we believe DiGi will likely enjoy almost similarly low effective tax rates in 4Q13. As a result, we revise our FY13 effective tax rate assumption lower to 20% from 25%.

Accelerated depreciation. Given that its network modernisation is fully completed, management does not expect any further accelerated depreciation from 4Q13 onwards. For 3Q13, management booked in the remaining MYR16m worth of accelerated depreciation. This brings total accelerated depreciation to MYR153m in FY13 (FY12: MYR566m).
Dividends. Management is still exploring the potential of a business trust structure, but has not reaffirmed whether it is able to conclude the evaluation by year-end. At this juncture, it is unable to provide further details.

Risks
The risks include: i) higher-than-expected net adds, ii) better-than-expected voice tariffs, and iii) benign competition.

Forecasts

After lowering our FY13 EBITDA margin assumption to 45.0% from 45.8% and imputing a lower effective tax rate of 20.0% (previously 25.0%), we raise our FY13 EPS by 5.3%. Our FY14 EPS forecast is tweaked marginally higher by 1.1% to 23.2 sen.

Valuation and recommendation
As the change to our FY14 earnings estimates is minimal, we maintain SELL on DiGi, with an unchanged FV of MYR4.10 (WACC: 8.5%, terminal growth rate: 1.5%). The group’s revenue growth momentum has been decent, but we note that its earnings got a substantial boost from tax incentives, which will expire this year. The absence of tax incentives in FY14 will lead to muted earnings growth. Besides, improving margins remains a challenge going forward due to competition and handset subsidies. Nonetheless, management is still exploring the possibility of a business trust structure, which could be a re-rating catalyst

Source: RHB