Telekom Malaysia - Slowing Unifi growth, rich valuations

- We downgrade TM to HOLD from BUY and lower our fair value to RM5.60/share from RM6.70/share previously, following a recent meeting with management. Our  valuation now pegs TM at a 10% discount to its DCF to  reflect a slowing earnings growth cycle. 

- Capex will not decline as much as expected in 2013 as despite a slower HSBB rollout, investments in network optimisation will keep HSBB capex elevated. We raise our capex projection for FY13F to RM2.3bil, in line with management guidance vs. RM2bil previously. In addition, we lower earnings by 1%-5% (FY13F-14F) to reflect increased competition and rising maintenance cost.

- Growth rate for Unifi subs looks to be peaking, along with the transition to a slower, demand-driven network rollout. Coupled with competition from re-sellers, Unifi subs may expand at a much slower pace going forward.

- TM does not intend to compete on price points, but competitive pressure may suggest otherwise, while HyppTV may require sometime before the brand can be strongly established through more attractive contents. Moreover, the pricing of Malaysian HSBB is one of the most expensive in the region – US$78 for 20-30mbps package versus US$20-46 for 50mbps download speed in Singapore and Hong Kong (See Table 1).

- Churn may rise going forward as more subs reach the expiry of their 2-year contracts. Unifi churn rate  has increased to 1% in 1H12 from 0.2%-0.3% a year ago. These contract expiries come at a time when re-sellers are aggressively undercutting pricing to establish their initial fixed broadband subs base. Further out, competition from 4G rollout by celcos may cannibalise fixed broadband growth, to a certain extent. We estimate 8% of Unifi subs base reaching contract expiry by end-2012 but this rises to 54% by end FY13F.

- Maintenance costs are rising as the warranty period for more parts of TM’s HSBB network reaches expiry. In 2Q12, maintenance cost rose 31% QoQ. Progressive rollout of HSBB network over the past 3 years means more parts of the network will see maintenance contracts expiring over the next 24-36 months.

- From a valuation standpoint, TM looks expensive relative to historical levels – trading at 1-standard deviation above the historical average EV/EBITDA and well above historical average PE. The share price has outperformed the index by close to 30% over the past 12 months. Given peaking Unifi growth rate (which has been its key earnings catalyst), we believe valuations are likely to revert to historical averages, notwithstanding potential dividend upside from FY14F. 

Source: AmeSecurities