Downgrading
the Telecommunication sector to NEUTRAL from OVERWEIGHT as we believe that the
sector’s near-term catalysts have been
essentially priced-in. Nevertheless, we believe the sector prospects remain
intact given the consensus estimates as well as ours have yet to fully
impute in the new potential upcoming catalysts
(i.e. a 6% prepaid service tax hike; the
final allocation of the 4G spectrum; infra and network collaborations
and the introduction of a new business model) into our financial models. If
these new catalysts materialise, which we believe the earliest could be seen in
4QCY12, could provide a re-rating spark again to the sector going forward. On
the flip side, we believe that the sector’s inflection point could happen when
1) they are limited rooms for further dividend yield compression; and 2) an
increase in risk appetite, which may result in the market shifting focus from
defensive to high beta sectors. On top of that, we also expect a temporary lull
in share prices in the sector during the General Election campaign period. We
are maintaining our OUTPERFORM calls on
TM with an unchanged target price of RM6.45, based on a targeted FY13
EV/forward EBITDA of 7.6x (+2SD). Digi, on the other hand, has been downgraded
to a MARKET PERFORM (from OUTPERFORM, previously) rating with an unchanged
target price of RM5.20, based on a targeted FY13 EV/EBITDA of 12.9x (+3SD).
Meanwhile, Maxis and Axiata MARKET PERFORM ratings and target prices remained
at RM7.35 and RM6.33, respectively, based on targeted FY13 EV/forward EBITDA of
13.0x (+3SD) and 7.7x (+2SD).
Time to sell or….While we believe that the sector’s near-term
developments have been essentially priced-in, the consensus as well as ours
have yet to fully impute in the following upcoming catalysts into our financial
models. Firstly, the deferment of the proposed 6% prepaid service tax hike;
secondly, the conclusion of the 4G
spectrum apparatus assignment (“AA”), which will see more products or services
being introduced; thirdly, the effect of more infrastructure and network
collaboration between the industry players and lastly, a new business model
under the business trust framework.
Should any one of these factors materialise, it will provide a re-rating
catalyst to the sector.
….continue to hold telecommunication stocks? In view of the abovementioned
potential catalysts, we are still recommending investors to hold and ride the
upward sector trend while waiting for the next catalyst to appear. On the other
hand, for those investors, who are more risk averse, we would recommend them to
trim part of their holdings to lock in profits, but they should buy in again
later at lower prices as the sector is still able to provide decent dividend
yields with solid operational performance during the current volatile
market.
When is the inflection point?
We believe that the sector’s upside is limited for now following the
strong share price rallies seen in the past two months, unless one of the abovementioned
catalysts materialise. In fact, we are expecting a temporary weakness in share
prices during the General Election (“GE”) campaign period, but it should
recover post the GE assuming that the federal power remains status quo. Apart
from the GE factor, the other inflection point could occur when 1) there are
limited rooms for further dividend yield compression and 2) the market started
to shift from the defensive to high beta sectors.
Inflection point has yet to occur so far.
Despite the strong YTD rallies in the sector’s stocks, both Digi and
Maxis still have rooms for further yield compression. Digi is currently offering
a decent dividend yield of 5.2%, based on our FY13 DPS forecast of 28.5 sen.
This is still far off from the group’s historical 3-year lowest dividend yield
of 4.32%. Similarly, Maxis still offers a strong dividend yield of 5.7%, based
on our FY13 DPS forecast of 40.0 sen, as compared to its historical 2-year
average dividend and lowest dividend
yield of 5.12% and 4.28%, respectively. Should we adopt these lowest yields to
our FY13 DPS forecast, Digi and Maxis could be valued at RM6.60 and 9.35,
respectively, under a ‘blue sky’ scenario. On the other hand, our GE study
suggests that defensive sectors (like consumer) may continue to outperform the
benchmark index in the post-GE period. This is in contrast to high beta sectors
(like property and construction), which tend to underperform the index during
the 1-6-month period after a GE.
Time to sell telco stocks?
The local telco sector has recorded an average YTD total return of 38.3% as compared to the benchmark
KLCI of 9.7%. The sector’s hefty YTD performance, which was led by Digi
(+47.1%) followed by TM (+38.1%), Maxis (+34.5%) and Axiata (+33.5%), was
mainly attributed to the stocks’ strong cash flow generation capability, stable
operational environment and more importantly, solid dividend commitment. Apart
from that, the sector index component status and its defensive shelter status
in nature have resulted in portfolio managers having to include in telco stocks
when constructing their portfolios, especially during the current volatile
market. While we believe that the
sector’s near-term catalysts have been essentially priced in, the consensus as
well as ours have yet to fully impute in the following upcoming catalysts into
our financial models. Firstly, the deferment of
the proposed 6% prepaid service tax hike; secondly, the conclusion of
the 4G spectrum apparatus assignment (“AA”), which will see more products or services being
introduced; thirdly, the effect of more infrastructure and network
collaboration between the industry players and lastly, a new business model
under the business trust framework. Should any one of these factors
materialise, which we believe the earliest could be seen in 4QCY12, it will
provide a re-rating catalyst to the sector.
The deferment of the proposed 6% prepaid
service tax hike.
To recap, all the celco companies had on 8 September 2011 announced that they
would impose a 6% prepaid service tax effective from 15 September 2011.
However, given the negative response from the public and the government post
the announcement, celcos have subsequently agreed to defer the plans until further
notice. There have been no further updates since then, and we believe that the
issue will only be re-discussed after the 13th General Election and will likely take months
before the conclusion can be finalised. While we are aware that celcos will
tend to benefit from the proposed prepaid service tax hike should the
government give the green light and the consumers’ consumption behavior remains
unchanged, there is no sign suggesting that this plan will materialise in the
near term at this juncture.
The conclusion of the 4G spectrum apparatus
assignment (“AA”) could provide an optimistic outlook to the sector. The Malaysian Communications &
Multimedia Commission (MCMC) is expected to finalise the allocation of the 2.6GHz (or 4G) spectrum and conclude the
AA (Apparatus Assignment) by year-end. We understand that not all the nine
players (i.e. Maxis, Celcom Axiata, Digi, U Mobile, Packet One, Asiaspace,
Redtone, YTL Communications and Puncak Semangant) will receive the spectrum
given that the authority has set the infra and network collaboration as part of
the pre-requirements for the assigning of any blocks of the spectrum to
players. The finalisation of the 4G spectrum AA will mark another corporate
milestone to the local mobile operators given that players will be able to
provide 4G services and more value-added services, add better user experience
as well as widen its revenue streams in a more cost-effective way. We believe
its impact have yet to be factored in by analysts in their forecasts due to the
lack of roadmaps provided by the mobile operators at this juncture.
More collaboration = more cost efficiency,
theoretically. We
believe that there will be more infrastructure and network collaboration
agreements being inked between the industry players in the next few months. Out
of this, Celcom and TM collaboration could potentially be on top of the list.
To recap, both Celcom and TM have entered into
a Memorandum of Understanding (“MOU”) to cooperate strategically in
providing fixed and mobile solutions in February 2011. While both parties, apart
from the HSBB service agreement which has been executed since June 2011, have
yet to conclude and finalise the other definitive agreements under the MOU,
such as 1) HSBB (transmission) and internet connectivity services for Celcom
subscribers; 2) digital subscriber line access services for Celcom subscribers;
fiber network system via long term lease
for Celcom network; and 4) mobile virtual network operator services to TM. We
do not discount that they may be potential ink some agreements in the future
given the MOU is still valid at this juncture.
The prolong negotiation of the MOU is expected given that there is a
strong likelihood that the agreement may involve a third party – Digi, thus
adding more complexity to form a conclusion. Note that both Digi and Celcom
have entered into a 10-year network collaboration agreement in January 2011,
and thus any further infrastructure collaboration arising from either party going
forward will need to get the consent or include the other party into the
picture, in our view.
Business trust framework – a potential new
corporate structure to Telco? The business trust industry has been given a boost under the Budget
2013 proposals, including income tax, stamp duty and real property gains tax
treatments similar to that of a company. Such business trust is suitable for
capital intensive companies with stable cash, and the upside is that it can distribute
quicker returns. Business trust, like real estate income trusts (REITs),
generally commits to pay regular dividends and is free to pay any amount of
dividends from its cash flow even if it does not make any profits. While the
details of the business trust framework has yet to be unveiled by the
government, we believe that it may potentially prompt the local telco players
to study the above business structure due to their strong cash flow generation
capabilities. This could provide a re-rating catalyst to the sector under the
above scenario given that telcos will be able to deliver a more than 100%
dividend payout ratio based on its strong cash flow.
A defensive sector that may lose steam
post-General Election? A school of thought has earlier suggested that the investment community
may potentially increase their risk appetites in the high beta sectors (i.e.
construction and property sectors) by shifting from the defensive sectors (i.e.
consumer and telecommunication sectors) in the post-General Election period (given
the clearing up of uncertainties then). Nevertheless, based on our study of the
past three General Elections, the high beta sectors tend to underperform the
benchmark KLCI index performance in the post one week; one-month; three-month
and sixmonth period after a GE while the defensive sectors tend to outperform.
As a result, there is a high chance that this historical trend may continue
post the upcoming 13th General Election.
Source: Kenanga
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