Telecommunication - Bottom Searching

We are maintaining our OVERWEIGHT view on the Telecommunication sector. Despite a lacklustre price performance for the YTD, the sector’s defensive nature and reasonable dividend yield will still be able to provide investors with the much-needed shelter during the current period of uncertainties. The sector’s outlook remains intact, in our view, judging from the incumbents’ FY13 KPIs and their earnings guidance. Based on our actual price/consensus target price study, we believe that there could be some nearterm trading opportunities in Telekom Malaysia (‘TM”) and Digi. Even if the trend of “flight to quality” is downplayed, we believe the sector could find its near-term floor level when the incumbents’ EV/forward EBITDA valuations fall to their respective mean levels. Valuation-wise, we have trimmed all our big capitalisation telco companies’ targeted standard deviation (“SD”) level by 0.5x each after taking the following factors into the consideration: 1) potentially higher than expected margin pressure; 2) lack of dividend upsides in the 1H and 3) the fact that LTE earnings opportunities may kick in only later rather than sooner due to the absence of an LTE eco-system. Our big capitalisation telco companies’ target prices fell by 2%-6% after the above-mentioned SD adjustments, which also implies a lower EV/forward EBITDA multiplier. TM (OP, TP: RM6.25 (from RM6.68 previously)) remains our top pick in the telco sector due to its solid presence in the FTTH market and the lesser competition seen in its wholesale and fixed-line segment. We also reiterate our OUTPERFORM ratings on both Maxis and Digi although their target prices are now lower at RM6.75 (from RM6.92 previously) and RM5.30 (from RM5.60) respectively. Meanwhile, our Axiata (MP) TP has been lowered to RM6.60 from RM6.86 previously. There is, however, no change in our OUTPERFORM call and target price on Redtone (TP: RM0.56).

4QFY12 results snapshot. Local telco players posted mixed 4QCY12 results. TM is the only incumbent that recorded better than expected results due to a higher turnover that was led by lumpy other telco related services segment income. Maxis and Axiata’s results were within the street and our expectations while Digi was hit by higher operating costs due to a higher handset subsidy and competitive IDD pricings. On the dividend front, all the incumbents’ full-year dividends came in within expectations except for TM, which failed to meet the market expectations of tabling a special dividend/capital management plan.

FY13 KPIs. All the incumbents are still expecting mid to single digit revenue growth in CY13 despite the intense competitions. Margin-wise, all the industry players are expecting some margin constrains as a result of the higher contribution from their data segment. Nevertheless, in absolute terms, players are still targeting to achieve a mild annual EBITDA growth, if not flat, suggesting the earnings outlook for telco operators are still intact in the current financial year.

Intensifying competition in the IPTV segment. Both Astro and Maxis have targeted to unveil their joint IPTV packages by end-April. We believe that it will provide a head-to-head competition to TM’s Unifi should the latter fail to implement its customer retention plans as well as enrich its current bundled IPTV plans.

Trading opportunities in TM and Digi? TM’s share price has corrected 13.1% for the YTD and is now at a 8.5% discount to its consensus target price (“TP”) of RM5.74. The discount is about 780 bps below TM’s 5-year actual price/consensus TP discount rate of -0.7%. Should TM’s consensus TP remain unchanged, this suggests some near-term trading opportunities may arise if the discount rate narrows to its mean level. Similarly, Digi’s share price is currently trading at a 8.9% discount to its consensus TP of RM4.85. The discount is about 700bps below Digi’s 5-year average actual price/consensus TP discount rate of -1.9%. In contrast, however, to the above two companies, Axiata’s actual price /consensus TP discount rate is now above its average level. This suggests a potential downside risk for the stock should the discount widen to its mean level. Maxis’ share price level, meanwhile, is fair in our view given that its discount rate is close to its mean level.

Near-term floor valuations. In view of the 13th GE concern / uncertainties, market could remain volatile. Apart from the ability to pay decent dividends, we believe that the sector could see excellent buying opportunity or could reach its near-term floor level when the incumbents’ EV/forward EBITDA valuations fall to their respective mean levels. Based on our estimate, Axiata’s share price could see its worst performance at its floor level to RM5.47 (-13.6%) followed by Digi (-9.5% to RM4.00), Maxis (-7.1% to RM6.05) and TM (-6.3% to RM4.92). Should the incumbents’ share prices fall to these floor levels, the sector’s dividend yield will be more reasonable at 4.9% as compared to the current 4.3%.

4QFY12 results snapshot. Local telco players posted a set of mixed 4QCY12’s results. TM is the only incumbent that recorded better than expected result due to higher turnover of its lumpy other telco related services segment income. Maxis and Axiata’s results were within the street and our expectations while Digi was hit by higher operating costs due to a higher handset subsidy and competitive IDD pricings. On the dividend front, all the incumbents’ full-year dividends came in within expectations with the exception of TM, which failed to meet the market expectations to table a special dividend/capital management plan. Moving forward, celcos are likely to unveil their respective LTE service detail road maps in the coming months, where we believe online video service could be a key focus even though the local 4G eco-system is not well prepared yet. Data traffic is expected to rise tremendously when the 4G eco-system is in place and this will ultimately benefit the network backhaul providers (i.e. TM and TDC) in the long run due to the higher data offloading demand.

FY13 KPIs and earnings guidance. While competition continues to intensify in the local telco sector, all the incumbents are still expecting a mid-single digit revenue growth in CY13 based on their latest KPIs as well as earnings guidance. Margin-wise, all the industry players are expecting some margin constrains in the current year, although this is not a major concern to us given that their revenue growth will be mainly driven by higher data contributions, which typically contribute lower margins as compare to the traditional voice business. In absolute terms, all the players are still targeting to achieve a mild EBITDA growth, if not flat, suggesting thus that the earnings outlook for telco operators are still intact in the current financial year.

Current dividend yields for both Maxis and Digi are still sound. Maxis has reiterated its intention to maintain another RM0.40/share dividend in FY13, which translated to a dividend yield of 6.2% based on its 15 March 2013 closing price of RM6.50. Based on our observation, Maxis’s current dividend of 6.2% still lies within the range of its historical 3-year average and its highest dividend yield of 5.21%-7.51%, suggesting thus that the stock still has some rooms for yield compression going forward.

Digi, on the other hand, in continuously finding ways to improve its shareholders value, the group intends to maintain its present dividend policy, which is currently set at a minimum 80% payout ratio and to be paid on a quarterly basis. In fact, the group has continued to reward its shareholders generously by declaring more than 100% dividend payouts in the past few years. Nevertheless, we saw some softening signs in its 4QFY12 results, where the group had merely declared a 2.5 sen or 80% payout ratio as compared to its 100% payouts in the past as highlighted above. We have thus lowered our FY13 DPS forecast to 18.4 sen after taking a more conservative view by reducing the targeted dividend payout ratio to 85% (from 100% previously) post its results above.

Based on our Digi’s FY13 DPS forecast of 18.4 sen, the group’s current dividend yield of 3.9% seems fair given that the yield is already close to its 4-year historical dividend yield range, albeit at the lowest end. Our FY13 DPS is about 35% lower as compared with the consensus DPS estimate of 24.8 sen, which we believe the latter to be likely premised on a 100% dividend payout ratio. Adopting the consensus FY13 DPS forecast of 24.8 sen to the group’s 4-year average and lowest dividend yields of 4.74% and 4.04% respectively, Digi could be valued at RM5.23-RM6.14 per share. Meanwhile, should we adopt a 100% dividend payout ratio into our financial model, its FY13 DPS forecast could rise to 21.6 sen, which suggests that the group could be valued at RM4.56-RM5.34/share based on its historical average and lowest dividend yield.

Scope for special dividends. Axiata has recommended a special dividend of 12 sen (FY11: nil) in conjunction with its 4QFY12 results release. The group has progressively increased its DPR (dividend payout ratio) from 30% in FY10 to 60% in FY11 and 70% thereafter. Going forward, we see a potential dividend upside on our current FY13 DPS forecast of 23.6 sen (3.8% dividend yield), which is based on a 70% payout ratio judging from the fact that the group has shown an intention to increase its DRP progressively. We estimate that the group still has ample cash of about RM5.7b (from RM7.9b as of end-FY12) after distributing a final dividend of RM1.3b (or 15 sen/share) and a special dividend of RM1.1b (or 12 sen/share). The group recorded a gross debt/EBITDA ratio of 1.7x as of end-FY12. The ratio is still below its optimal capital structure of 2.0-2.2x gross debt/EBITDA level, suggesting that Axiata still has rooms to leverage up its balance sheet if needed.

TM, on the other hand, has disappointed the market with the absence of a special dividend/capital management plan in FY12. Despite the disappointment, we still believe that there could be still scope for the group to declare special dividends in FY13 albeit the quantum may not be the same as what shareholders have enjoyed in the past (RM1.07b or RM0.30/share each for both FY10 and FY11). Management has argued that the absent of the special dividend in FY12 was mainly due to the lack of further co-HSBB investment by the government as well as the company preserving its cash for competition ahead. Nonetheless, in view of its declining capex trend coupled with its strong retained earnings (RM4.2b as of end-FY12) as well as its underleveraged balance sheet (2.1x gross debt/EBITDA ratio as of end-FY12 as compared to its maximum optimal capital structure ratio of 2.5x), we hence do not discount that there could be some dividend surprises by end-FY13. All in all, we reckon that the possibility of a special dividend For TM in FY13 will likely only be apparent in the late 2H. As such, we are maintaining our TM’s FY13 DPS forecast of 19.9 sen for now, which is based on a targeted 90% dividend payout ratio.

Intensifying competition in the IPTV segment. Both Astro and Maxis are targeted to unveil their joint IPTV packages by end-April. Based on our earlier understanding, the upcoming Astro-Maxis IPTV packages will be likely be priced at a similar level to the current Astro-Time IPTV packages. As such, we believe that the former’s packages will be priced at between RM248 and RM378 per month, depending on the broadband speed powered by Maxis.

Under the current Astro-Time IPTV packages, Astro is packaging its TV contents via four super pack products ranging between RM100-RM130/month. We understand that the Astro super packs are its four new Astro packages that are tailored made to suit each customer needs. They comprise the best of Astro’s channels and packages, including Astro Family, Sports, Movies, a choice of three Minis and at least two vernacular packages. On top of that, the packages also include premium Astro services such as High Definition and Personal Video Recording. Note that some Media Prima’s channels (i.e. NTV7 and 8TV), channel Al Hijarah (114) and TV1 (180) are not available on Astro B.yond IPTV at this juncture.

TV content-wise, we understand that the upcoming Astro-Maxis IPTV packages will be similar to the current Astro-Time IPTV, where Astro may bundle all its channels under the same superpack packages. On the subscriber front, we understand that Astro-Maxis IPTV subscribers will be classified as Astro’s users and Astro will receive all the TV content APRU as well as certain percentages from the broadband ARPU. Astro-Maxis IPTV subscribers will receive a single itemized bill from Astro. Meanwhile, we also understand that Astro is eyeing to record a number of 500k IPTV subscribers within the next 3-5 year period.

Source: Kenanga