Digi’s 3Q15 results underwhelmed our/market expectations. Downgrade to NEUTRAL with a revised DCF-based TP of MYR5.80 (5% upside), after reducing our FY15-17 core earnings forecasts by 8-9%. Mid-term earnings prospects remain challenging due to unrelenting market competition. However, Digi’s wider LTE coverage (>50% penetration)should bolster brand affinity and drive stronger data growth.

Taking a beating. Digi.com’s (Digi) 3Q15 came in below expectations at66%/69% of our/street estimates as operating conditions remain challenging. Service revenue growth continued to be flattish (9M15: +1.2%) amidst the prolonged weak consumer sentiment post-goods and services tax (GST) and the fierce market competition. Digi was also hit by a MYR50m forex loss as a result of higher traffic cost from a weaker MYR in 3Q15. This factor and higher overall opex led to a lower EBITDA margin of 42.9% (2Q15: 45.7%). Digi announced a DPS of 5.1 sen,which translates to a 100% payout ratio, bringing 9M15 DPS to 17.1 sen.

Outlook. Digi sounded less upbeat on its outlook as competition remainsintense and given the extended weak market sentiment. It has retained its KPIs for 2015 but expects service revenue growth to come in at the low-single digit guidance. Digi’s forex exposure (most of its international traffic cost is denominated in the USD) and its bigger share of the migrant market could portend further earnings downside. On a brighter note, Digi is currently in pole position in terms of its LTE footprint and is planning to roll out another 1,500 sites by year-end. With only 13.2% of its total subscribers (subs) on LTE currently, we believe it could capitalise on the wider LTE exposure to drive better data monetisation.

Forecasts. We lower our FY15-17 core earnings forecasts by 8.3-9.3%,mainly on the back of lower service revenue growth and EBITDA assumptions as we factor in stronger competition and higher opex.

Downgrade to NEUTRAL. We downgrade Digi to NEUTRAL (from Buy) based on a revised DCF-based TP of MYR5.80 (WACC: 7.2%, TG: 3.0%) (from MYR6.30) given the limited upside. The sector’s mid-term prospects remain challenging on the back of unrelenting competition and the uncertainty over the mechanics of the GST rebate announced in Budget 2016.

Key takeaways from results call Digi’s 3Q15 results call was hosted by its CEO Mr Albern Murty, CFO Mr Karl Erik Broten and chief marketing officer (CMO) Christian Thrane. The key queries raised were the reasons for its forex losses, the competitive landscape and its LTE expansion plans. Digi has reaffirmed its guidance on revenue, EBITDA and capex for FY15.

Competition remains a key risk. Digi highlighted that competition in the market remains intense, as mobile operators went on the offensive to stimulate usage amid the weakened consumer spending post-GST. To maintain its value proposition, Digi responded with few new LTE-ready plans – Digi Best Prepaid and Digi Smart Prepaidand revamped its postpaid offering, Digi SmartPlan. Although its blended ARPU has remained stable QoQ at MYR45, there could be some downside in 4Q15 due to the cannibalisation of lower-priced plans which offer more bang for the buck.

We see downside risk to the industry’s revenue growth prospects should the price competition be drawn out. Digi has retained its headline KPIs for 2015, although it believes that revenue growth will likely come in at the lower end of its “low to mid single digit growth” guidance. We note that Digi’s Direct Operator Billing arrangement with operators such as iFlix, HyppTV and Google Play Store could help increase its subscribers’ wallet share, especially within the prepaid segment.

Forex impact. Digi booked forex losses of MYR50m and MYR37m at the EBITDA and PAT levels respectively. This came from a spike in international direct dial (IDD)traffic cost (and translation losses between the transaction and settlement rate) ,coupled with the higher termination rate of a key IDD destination which drove overall traffic cost higher by 13% QoQ. Its major IDD destinations – Bangladesh, Indonesia and Pakistan saw their currencies strengthen against the MYR by 7-14% QoQ and 12-26% YoY, while the steep 16.5% depreciation of the MYR against the USD (3Q15 USD/MYR rate: MYR4.40) impacted international traffic cost. Although management expressed that the losses were one-off, we do not rule out further forex losses ahead, given Digi’s larger exposure to the migrant market, and as the MYR remains weakagainst the currencies of its major IDD destinations.

LTE footprint expansion to improve its competitive edge. We expect Digi to continue benefitting from the improvement in network quality and its expanding LTE footprint which currently stands at 50%, surpassing Maxis (MAXIS MK, SELL, TP: MYR5.70) and Celcom. Despite its wide LTE footprint, we note that currently only 13.2% of total subs or 1.5m subs are LTE users, hence there is still room for Digi to capitalise on the LTE growth to drive data monetisation, as reflected in its double digit data revenue growth. Digi is keeping its MYR900m capex guidance for FY15 as it plans to roll out additional 1,500 LTE sites by end-2015 and to achieve a target of 6,100km fibre network footprint.

Forecasts We lower our FY15-17 core earnings forecasts by 8.3-9.3%, after factoring in: i) slower service revenue growth of 2-3% per year from 3-5% previously amidheightened market competition, and ii) lower EBITDA margin assumptions of c.43% (from 45%) arising from higher traffic cost and an increase in our opex assumptions. Key earnings risks are: i) higher-than-expected competition/lower-than-expected EBITDA, and ii) higher-than-expected capex.

Valuation and recommendation Downgrade to NEUTRAL. We downgrade Digi to NEUTRAL (from Buy) based on a revised DCF-based TP of MYR5.80 (WACC: 7.2%, TG: 3.0%) (from MYR6.30) given the limited upside. That said, we note that Digi’s trading FY15F P/E of 22.7x is still below its peers’ 23.8-30.3x. Digi is also currently the only telco player that is offering a dividend yield of above 4%. The sector’s mid-term prospects remain challenging onthe back of unrelenting competition and the uncertainty over the mechanics of the GST rebate announced in Budget 2016.