This article first appeared in The Edge Financial Daily on October 20, 2017

DiGi.Com Bhd
(Oct 19, RM4.77)
Maintain hold with a target price of RM5.15: A quarter-on-quarter (q-o-q) service revenue growth of 2% and direct cost savings helped lift DiGi.Com Bhd’s third quarter of financial year 2017 (3QFY17) earnings before interest, taxes, depreciation and amortisation (Ebitda)-to-service-revenue margin to 51%. Nine-month (9MFY17) net profit of RM1.117 billion (-10% year-on-year [y-o-y]) was in line with expectations.

The y-o-y earnings decline was due to the ongoing crackdown on illegal immigrants (leading to lower migrant subscribers) and declining legacy prepaid voice and messaging revenue. Positively, the group arrested the prepaid revenue decline and continued to gain good traction in the post-paid business.

As DiGi continued to focus on its Internet proposition (anchored by rapidly expanding long-term evolution [LTE] coverage) and good cost discipline, 3QFY17 net profit grew 7% q-o-q to RM385 million (-12% y-o-y). This brought 9MFY17 core net profit to RM1.117 billion (-10% y-o-y). We deem the results to be within house and street estimates.

For the quarter, DiGi lost 178,000 subscribers due to high customer churn within the prepaid segment. That said, DiGi continued to make good progress in the post-paid segment, gaining 103,000 customers in 3QFY17, with some natural migration (upgrades) from the prepaid segment.

Overall, DiGi was able to arrest the average revenue per user (Arpu) decline (especially in the prepaid segment) with its 3QFY17 blended Arpu of RM41 per month. Prepaid Arpu was stable (since 1QFY17) at RM32 per month as the group recalibrated its international direct dialing (IDD) pricing and focused on better subscriber quality and margins.

DiGi has moved away from the irrational IDD price war since the early part of 2016, and this has resulted in stabilisation within the prepaid segment (since 3QFY16). More importantly, post-paid revenue surged 14% y-o-y and 4% q-o-q on the back of a higher subscriber base.

A stronger Internet proposition and good cost discipline helped lift its Ebitda-to-service-revenue margin by two percentage points (ppts) q-o-q to 51.3% of service revenue. Y-o-y, its Ebitda-to-service revenue margin has improved by 1.4ppts as DiGi is focusing on Malaysian prepaid profitability (focusing on its Internet proposition) and keeping direct and marketing costs under control. Together with lower interest expense (partly due to the issuance of RM900 million Islamic bonds in April), 3QFY17 core net profit rose 7% y-o-y to RM385 million (-12% y-o-y).

DiGi will focus on maintaining its No 1 position in subscriber base and No 2 position in service revenue market share. Moving forward to the next two years, DiGi sees opportunities within the Malaysian prepaid and post-paid market segments. This is anchored by its good network coverage and an improvement in in-building coverage following the additional 900MHz spectrum allocated as of July.

The target post-paid customer base is within the entry and middle-income levels (an Arpu of about RM70 per month). More importantly, this will help the group dilute revenue concentrated within the migrant prepaid segment. Management has shared that they now have a fairly distributed revenue stream from both the migrant and Malaysian prepaid segments.

We expect the group to achieve a core net profit of RM1.494 billion (-10% y-o-y) and RM1.589 billion (+6% y-o-y) in FY17 and FY18 respectively. Amid continued competition and weak consumer confidence, DiGi is expected to focus on monetising its wide 4G-LTE and LTE-A networks to strengthen its post-paid position in the market, and to capture opportunities from growing Internet demand in the Malaysian prepaid segment.

Risks include: i) the entry of Telekom Malaysia Bhd’s subsidiary, webe, into the prepaid segment by the second half of 2017, which creates short-term pricing competition in its bid to win market share; and ii) a severe economic downturn.

Amid market volatility, DiGi offers a 4% net yield, which we believe is sustainable amid the pedestrian earnings outlook and low gearing levels. — UOB Kay Hian, Oct 19