We  remain  NEUTRAL  on  the  telco  sector,  as  most  of  the  upside  has been priced  in  and  valuations  look  fair.  We believe that the cellcos are bracing for more  headwinds in light of the  heightened competition  and the continued decline in  legacy  revenues.  The GST impact will likely be positive  over  the  longer  term,  although  we  expect  some  drop  in consumption over the short term due to slower consumer spending.

Cellcos  bracing  for  more  headwinds.  Going  into  2015,  cellcos  may continue  to  face  headwinds  in  monetising  data  while  legacy  revenues (SMS  and  voice)  should  remain  under  pressure  on  the  back  of  higher data  uptake  and  smartphone  adoption.  Competition  should  remain intense,  especially  with  unlisted  U-Mobile  upping its  ante  and  Telekom Malaysia (TM)  (T MK, NEUTRAL, TP: MYR7.00) rolling out a converged LTE mobile offering following its acquisition of P1. Thus far, the growth in data  revenue  –  stemming  from  the  accelerating  growth  in  mobile revenue  –  has  only  been  able  to  partially  offset  the  loss  in  traditional voice  revenue  as  the latter  still makes  up  almost  two-thirds  of  industry service revenue. 

GST implementation  a  double-edged  sword.  The  introduction  of  the goods  and  services  tax  (GST)  is  generally  seen  as  positive  for  the cellcos,  especially  those  with  larger  exposure  to  the  prepaid  segment, such  as  Digi  (DIGI  MK,  NEUTRAL,  TP:  MYR6.60)  and  Maxis  (MAXIS MK,  NEUTRAL,  TP:  MYR6.35).  The  cost-savings  from  the  6%  service tax pass-through should bolster cellcos’ earnings by 2-6% for FY15, if all factors are unchanged.  That said,  the  actual cost savings could come in lower over the short term as there could be a drop in consumption due to the  anticipated  slowdown in  overall  consumer  spending  post  GST  and given the price-sensitive nature of most prepaid subscribers. 

Spectrum re-farming  likely  to be  delayed.  There  is  still  little  visibility on the timeline of the spectrum refarming as there have been no updates on the matter. Hence, we believe the exercise may likely only take place in 2H15 at the earliest. We see Digi as a likely beneficiary of the exercise as it currently has limited 900Mhz spectrum and needs more to re-farm the  1,800Mhz  spectrum  for  LTE.  That  said,  as  the  structure  of  the  refarming exercise has yet to be decided upon, the spectrum tenders could be  opened  up  to  other  new  and  emerging  players,  and  this  could potentially threaten the positions of the current players in the sector.

Maintain NEUTRAL.  We believe that at this juncture, most of the upside on  the  sector  (ie  GST)  has been  priced in  and  valuations already  look fair.  The  current  unfavourable  market  outlook  and  the  uneven  global macroeconomic  recovery  may  benefit  the  sector,  given  its  defensive nature and decent dividend yields. Axiata  (AXIATA MK, NEUTRAL, TP: MYR7.20) is our preferred pick.

Cellcos bracing for more headwinds

We are NEUTRAL on the telco sector going into 2015 as we believe the  cellcos  will continue  to  face  headwinds  in  monetising  data  while  legacy  revenues  (SMS  and voice)  should  remain  under  pressure  on  the  back  of  higher  data  uptake  and smartphone  adoption.   Based  on  the  9M14  results  of  the  cellcos,  industry  voice revenue  declined  5%  YoY  while  SMS  revenue  plunged  27%  YoY  due  to  a combination of company-specific and structural weaknesses. The industry’s service revenue  growth  (which  excludes  handset  sales)  has  fallen  for  three  consecutive quarters  on  a  YoY  basis,  contracting  1.4%  in  9M14  vs  a  1%  growth  in  2013. Meanwhile, data revenue has continued to rise steadily at about 2-3% YoY, driven by accelerating growth in mobile internet (MI) revenue (9M14: +23% YoY). The growth in  data  revenue  has  only  been  able  to  partially  offset  the  loss  in  traditional  voice revenue as the latter still makes up almost two-thirds of industry service revenue. Going  forward,  we  remain  cautious  on  the  growth  prospects  for  the  sector  as  the three m ajor cellcos, Digi,  Celcom and Maxis  will continue to face headwinds  in the form  of:  i)  the  structural  decline  in  legacy  revenues,  and  ii)  the  more  intense competition anticipated, especially with U-Mobile  upping its ante and TM rolling out a converged  LTE  mobile  offering  following  its  acquisition  of  P1.  The  additional competition and the impending implementation of the GST could well translate into more pricing pressure for the cellcos and the industry in 2015.

GST implementation – a double-edged sword
The introduction of  the  GST is generally seen as positive for the cellcos, especially those  with larger  exposure  to  the  prepaid  segment,  such  as  Digi  and  Maxis.  Post GST, the mobile operators will no longer need to absorb the 6% service tax and can pass this on to prepaid subscribers. The cost  savings should bolster the earnings of the cellcos to  the tune of 2-6% for FY15, based on our estimates and assuming a nine-month impact and all else being equal.

That  said,  we  note  that  prepaid  users  (which  account  for  80%  of  overall  industry subscribers)  are  typically  more  price sensitive  and  could  adjust  their  spending patterns.  Furthermore,  we  are  anticipating  a  short-term  slowdown  in  overall consumer  discretionary  spending  as  consumers  turn  more  cautious  on the  back  of the  higher cost of living  and the  uncertainties  arising from the GST  implementation. At the same time, the Malaysian Institute of Economic Research’s (MIER) consumer sentiment index has dropped to below the threshold of 100, ie by 2.1 ppts to 98.0% in 3Q14,  indicating softer  consumer sentiment.  We think the cautious sentiment could spill  over to the telco sector  –  although communication  services are largely deemed as basic necessities. As such, over the short to medium term, the anticipated cost savings  from  the  GST  pass-through  may  be  somewhat  offset  by  lower  overall consumption  due  to  the  slowdown  in  consumer  spending  or  cellcos  potentially passing  on  part  of  the  tax  only,  in  our  view.  We  believe  the  situation  would  likely normalise after 3-6 months post GST, as consumers start to embrace a new normal.

Spectrum re-farming likely to be delayed

Although the re-farming of the 900Mhz and  1,800Mhz spectrum was initially mooted back in 2012,  there  continues to be  little visibility on the timeline of the exercise as the  Malaysian Communications and Multimedia Commission  (MCMC) remains tightlipped and the telcos are not able to offer any updates on the matter. The structure of the re-farming exercise (ie  auction, direct assignment or beauty content) has also yet to be decided upon, based on our channel checks. Hence, we believe the exercise may  likely  only  take  place  in  2H15  at  the  earliest.  In  our  opinion,  it  would  not  be unreasonable to assume that Digi stands to benefit most from the re-farming process as it currently has limited 900Mhz spectrum and needs more to re-farm the 1,800Mhz spectrum for LTE. That said, as the structure of the re-farming exercise has not been decided, the MCMC could open up the spectrum tenders to other new and emerging players, and this could potentially threaten the positions of the current players in the sector.

HSBB2 in 2015
TM  is  still  awaiting  the  official  letter  of  award  (LOA)  from  the  G overnment  for  the Phase II of the high-speed broadband project (HSBB2),  which is to be built at a cost of  MYR1.8bn.  The  media  had  previously  reported  that  the  incumbent  intends  to upgrade  an  additional  100  exchanges  for  high-speed  broadband  access  under HSBB2,  which also includes some investments to enhance broadband services for the general population.  TM added 27k  Unifi  customers in 3Q14, slightly higher than the 20k netted in 2Q14,  although YTD additions  of 65k remain below that of the over 150k  captured  in  FY13  as  its  take-up  rate  has  risen  above  50%.  Given  that  the HSBB2 project was reiterated again in Budget 2015, we believe the award will likely happen  in  2015.  We  note  that  TM’s  current  nomadic  wireless  broadband  service, TMgo  –  launched  in  2Q14  –  has  expanded  its  coverage  to  nine  states  including Sabah and Sarawak  from just two previously, increasing the size of its addr essable market. Over the longer  term, we believe TM will look into the bundling of   its fixed broadband  product  with  its  mobile  offering  (under  P1)  to  emerge  as  a  leading converged operator.

Key risks

The key risks to the sector include: i) the more intense competition from new players,ii)  a prolonged cautious or negative consumer sentiment post GST,  iii)  faster  decline in legacy revenues as compared with the growth in mobile internet,  and iv) delays in the awarding of the HSBB2 project.

Maintain NEUTRAL
We are NEUTRAL on the telco sector for  2015  as we  believe that at this juncture, most of the upside on the sector (ie GST) has been  priced in with the share prices of the  telcos  having  appreciated  by  1-12%  over  the  past  3-6  months  and  valuations already  looking  fair. We  project  tepid  industry  service  revenue  growth  of  2-3%  for 2015,  from  a  slight  decline  to  flattish  growth  in  2014,  al though  margins  will  likely remain  stable.  Competition  in  the  market  should  remain  relatively  intense  as  UMobile  sets  about  in  achieving  its  subscriber  targets  and  aggressively  expands  its 3G/4G coverage while P1 is expected to introduce a converged mobile  product. We also believe that investors could turn more defensive in 2015, given the unfavourable market outlook and the uneven global macroeconomic recovery. This could benefit the telco sector as a whole,  backed by the generally strong cash  flows and balance sheets of the telcos, which also boast decent dividend yields of about 4-5%. Note  that  our  call  for  Digi  has  been  downgraded  to  NEUTRAL  (from  Buy)  as  we believe  the  potential  upside  from  the  GST  has  been  priced  in,  and  given  that  the positive  impact  post-GST  may  be  mitigated  by  its  more  price-sensitive  customers. Axiata  is our  preferred pick for the sector, as we believe that: i) Celcom’s internal ITtransformation issues are behind it and it is  now in a better position to compete  via the  launch  of  new  products,  and  ii)  synergies  from  the  XL-Axis  integration  in Indonesia would  start to filter through with the merger set to be EBITDA-positive in 1Q15. Axiata is the only listed Malaysian telco offering regional exposure with a key medium-term  rerating  catalyst  in  the  form  of  the  listing  of  its  wholly-owned  tower company, e.Co.

Source: RHB