Digi remains a NEUTRAL with an unchanged DCF-derived TP of MYR4.70 (0% upside) premised on the following: 1. The stiff competition in the market which portends downside risks for industry ARPU and margins; 2. TM’s entry in the mobile segment (webe) could prove to be disruptive and intensify the already-aggressive market competition; 3. Its stronger balance sheet should mitigate the spectrum fee impact and dividends paid out.

Postpaid makes further inroads. Despite posting stronger growth in the postpaid segment, Digi.com (Digi) maintained its cautious stance/guidance given the stiff competition in the market. We share similar concerns, noting the impending launch of a new mobile LTE service (webe) by 3Q16 and the more equitable spectrum distribution partially explained the stronger acquisition/retention activities to date. 1Q16 results were in line, making up 22% of our and consensus estimates respectively. Strategy. Digi intends to further differentiate its services by improving its value propositions and delivering greater innovation. The telco is also segmentalising customers better to help preserve its ARPU. Management has reiterated the focus on cost discipline to optimise operating efficiency and performance. Risk. We make no changes to our earnings forecast. The downside risk to our recommendation includes greater decay in ARPU due to competition, while upside risks include better-than-expected customer subscriptions.

Maintain NEUTRAL. Digi’s valuations are backed by its stronger balance sheet (net debt/EBITDA of 0.4x), which leaves it less vulnerable to spectrum payouts, in addition to the relatively attractive dividend yield of 5%. Our DCF-derived TP of MYR4.70 (WACC: 7%, TG: 3%), implies 12.4x FY16F EV/EBITDA, marginally above the industry’s average of 11.5x.

Key Takeaways From The Results Call

Silver lining in postpaid. Digi posted robust growth in the postpaid segment in 1Q16 due to its stronger data network and customer-centric postpaid offers. The telco’s 4G LTE network now covers 73% of the population nationwide, from 65% in 4Q15. Management acknowledged that competition has moved from the prepaid segment to the postpaid as consumers remain ever-hungry for larger data bundles. As such, we believe that Digi’s focus on the data network could help ease ARPU pressure by gaining larger market share. Further, a larger contribution from the postpaid segment would help dilute earnings sensitivity from the prepaid segment, which has traditionally been the most reactive to price competition. Spectrum update. There have been no further updates from the Malaysian Communications and Multimedia Commission (MCMC) with regards to the spectrum fee structure. Management has also shared its expectations of a balanced distribution by the MCMC of the remaining 700MHz, 2300MHz and 2600MHz spectrum bands, to help reach the nation’s goal of affordable and high quality internet services. Operational performance and guidance. Digi continued to gained market share at the expense of Maxis, where the former added 211,000 pre- and postpaid subscribers while the latter lost 384,000 subscribers. We believe this was due to the delay in Maxis introducing its revamped MaxisONE plan upgrades, while Digi successfully rolled out attractive plans with more affordable pricing points. Digi maintained its 2016 guidance of flat service revenue, EBITDA and capex growth. Dividend. Digi declared a 5.1 sen DPS for 1Q16, payable on 24 Jun, which represented an almost 100% earnings payout ratio.

Maintain NEUTRAL. We remain cautious on Digi’s prospects due to: i. Unrelenting industry competition; ii. The imminent entry of TM’s mobile LTE service; and iii. Its bigger exposure to the more price-sensitive prepaid segment (70% of mobile revenue). Valuations are, nonetheless, backed by Digi’s stronger balance sheet (net debt/EBITDA of 0.4x), which means it is less vulnerable to spectrum payouts. This is in addition to the relatively attractive dividend yield of 5%. Our DCF-derived TP of MYR4.70 implies 12.4x FY16F EV/EBITDA, marginally above the industry’s average of 11.5x.

SWOT Analysis

Source: RHB Research - 25 Apr 2016