In 2QCY24, fixed and mobile players all met or exceeded our expectations, but a telco tower operator missed due to slower network roll-out of contracts. Coverage-wise, this resulted in 20%, 60%, and 20% beating, meeting and missing our projections respectively. The sector’s 1HCY24 core net profit jumped 22% YoY, mainly driven by AXIATA (OP; TP: RM2.75) as its high-growth markets provided a boost to the overall sector, as other domestic players navigated a competitive landscape in both mature or maturing markets. QoQ, ARPU and subscriber trends were mixed - (i) postpaid: sustained net adds and ARPU erosion, (ii) prepaid: uneven net adds/loss and stabilizing ARPUs, and (iii) home fiber: healthy net adds but weaker ARPUs (except for MAXIS (MP; TP: RM3.74). The QoQ trends were largely within expectations, except for weaker home fiber ARPU for CDB (OP; TP: RM5.59) and TM (OP; TP: RM7.53). We maintain OVERWEIGHT as the looming announcement on the 5G Dual Network (DN) policy will remove uncertainty around earnings, capex and dividends. Meanwhile, fixedline players are poised to benefit from the proliferation of data centers in Malaysia, which would likely to boost demand for global and terrestrial bandwidth services. Our sector top picks are CDB and TM.

Mild expansion in service revenues. In 2QCY24, fixed and mobile players all either met or exceeded our expectations, but a telco tower operator missed due to slower network roll-out of contracts. This resulted in 20%, 60%, and 20% of stock coverage beating, meeting and missing our projections respectively, compared with 100% meeting our expectations three months ago (Exhibit 1). 1HCY24 service revenue for domestic mobile players nudged up 1.4% YoY, mainly driven by MAXIS’ enlarged postpaid subscriber base. To a lesser extent, the expansion was also propelled by snowballing home fiber subscriber net adds at MAXIS. In our view, service revenue growth for mobile players in 1HCY24 appear sluggish in comparison to their full-year guidance of low-single digit growth. This was likely due to heightened competition within the prepaid segment, particularly from the mobile virtual network operators (MVNO).

Meanwhile, revenue for fixed player TM was flattish, as expansion in other businesses were offset by lower ARPU at Unifi. Similar to the prepaid space, we believe competition in the fixed broadband segment is heating up, as mobile players turn aggressive to achieve their convergence strategies.

Earnings growth anchored by AXIATA.The sector’s 1HCY24 core net profit jumped by 22% YoY, mainly driven by AXIATA on the back of ARPU strength and cost discipline at XL and Smart. Additionally, earnings were boosted by CDB as its accelerated depreciation trailed off and taxes were lower (due to adjustments and incentives). This more than offset bottomline drag from TM as its 1HFY23 profit was boosted by the recognition of tax credits. In essence, earnings growth in AXIATA’s high-growth emerging markets provided a crucial boost to the overall sector in 1HCY24, as other domestic players navigated a competitive landscape in both mature and maturing markets.

Stabilizing prepaid ARPUs… Prepaid ARPUs appear to have stabilized in 2QFY24, as it remained stable for Celcom and MAXIS, but inched up slightly for Digi on sequential basis. This alludes that prepaid ARPUs may have troughed at RM29 for MAXIS and RM25 for Digi in 2QFY24. This is after declining steadily from their recent peaks of RM32 in 4QFY22 for MAXIS, and RM29 in 2QFY22 for Digi. On the other hand, prepaid ARPU for Celcom is showing signs of peaking at RM25 in 2QFY24 after rising steadily from RM28 in 1QFY22. Overall, we attribute the stabilizing prepaid ARPUs in 2QFY24 to rationalizing competition, as the players scale back their aggressive stances to protect against further ARPU erosion. Hence, this is positive for Digi and MAXIS, which has a larger proportion (21%) of prepaid users versus Celcom (16%).

…but postpaid ARPU continued downward trend. On the other hand, Postpaid ARPUs sustained its QoQ decline, as mobile network operators (MNO) continued their strategy to encourage pre-to-postpaid migration. ARPUs have progressively declined from their recent highs in 2022 (Celcom: RM81, Digi: RM64, MAXIS: RM73) to current levels of RM75 (Celcom), RM58 (Digi) and RM68 (MAXIS). This reflects the popularity of entry level postpaid plans introduced by the large MNOs, which are priced as low as RM30-RM40 per month.

Mixed trends in prepaid net adds. Competition in the prepaid segment remains escalated, as evident from the mixed performance among the main MNOs in 2QFY24. Celcom’s QoQ net subscriber losses, which began in 4QFY23, moderated to 79k. However, Digi experienced a significant increase in net attrition, which more than quintupled to 299k in 2QFY24. In contrast, MAXIS outperformed, reversing its 1QFY24 net losses with strong net addition of 100k subscribers. We believe these trends reflect the major telcos’ reluctance to engage in intense price wars with mobile virtual network operators (MVNO), opting instead to cede market share.

Sustained momentum in postpaid adds. On a positive note, the major MNOs continued to experience healthy sequential postpaid net adds. In 2QFY24, both CDB and MAXIS achieved robust net adds of 118k and 96k, respectively, which is aligned to their pre-to-postpaid migration strategy (as mentioned above). In particular, CDB’s QoQ postpaid net adds snowballed from 20k in 4QFY22 to 118k in 2QFY24, possibly reflecting its effective post-merger marketing strategies.

Brewing competition in the fixed market. For the fixed segment, Unifi’s 2QFY24 ARPU weakened QoQ to RM128 (1QFY24: RM130) due to promotional discounts and a higher number of new subscribers on entry-level packages. On the bright side, Unifi’s subscriber net adds inched up sequentially to 11k (1QFY24: 9k), likely due to the attractive discounts. Meanwhile, consumer fiber net adds for the other players in 2QFY24 also inched up sequentially (MAXIS: +13k, CDB: +18k). However, while MAXIS’ sequential ARPU remained resilient at RM110, CDB’s ARPU fell to RM107 (from RM112). Against this backdrop, we surmise that MNOs have become increasingly aggressive in the home fiber segment via belowthe-line marketing discounts to attract subscriptions for its converged bundles.

Maintain overweight. We believe stock valuations and sentiment for MNOs will recover once the government announces the official 5G Dual Network policy directive. This will finally remove the uncertainty around earnings, capex and dividends that have weighed on the sector. Recall that TM, CDB, MAXIS and YTLPOWR (OP; RM5.20) have submitted their tenders to develop the second network, with the results expected in 3QCY24.

To recap, forward average forward EV/EBITDA valuations for the MNOs have dipped by 30% from 12.6x in Feb-21 to current levels of 7.7x. We attribute this to the announcement of the single wholesale network model, which has altered the sector economic dynamics. We understand that access payments for the first 5G network commenced in 4QCY22 and 4QCY23 for CDB and MAXIS, respectively. Despite this, EBITDA margins for CDB expanded from 47.2% in FY21 to 49.4% in FY23 before easing to 46% in 1HFY24. Although MAXIS’ EBITDA margins dropped from 47.2% in FY21 to 46% in 1HFY24, they remain robust, and does not justify the dip in valuations, in our view. Therefore, the decline in valuations, despite unfounded earnings concerns, may reverse once the 5G DN policy is unveiled, and regulatory uncertainty diminishes.

Meanwhile, the fixed-line players are poised to benefit significantly from the ongoing surge in investments in data centers (DC), cloud and AI infrastructure in Malaysia. This will likely drive increased data transmission between DCs and endusers, thus boosting demand for global and terrestrial bandwidth services via fiber optics and submarine cables. We maintain our OVERWEIGHT recommendation on the sector with our top picks being 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, and (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 submarine cables and landings, as well as terrestrial fiber optics backhaul.

We like CDB for the following reasons: - (i) having achieved net merger synergies of RM701m in 1HFY24, the group is on track to reach its target NPV of RM8b in synergies over 5 years – emanating from network (RM5.5b), IT (RM1.1b) and others (RM1.4b), (ii) robust average FCF yield of 7.7% in FY24-25 implies capacity to pay steady dividends, and (iii) being the largest mobile subscriber base in Malaysia, translating to economies of scale.

Source: Kenanga Research - 9 Sept 2024