This article first appeared in Corporate, The Edge Malaysia Weekly, on May 23 - 29, 2016.

AFTER shedding nearly 20.58% of its share price to close at RM4.47 last Friday, DiGi.Com Bhd now offers a yield of 4.71%, based on an estimated dividend per share of 21 sen for financial year 2016.

As far as dividend yields go, it is not particularly attractive, but it is not too bad either. Analysts, however, are still relatively bearish on DiGi.

A quick check on Bloomberg shows that analysts have a consensus target price of RM4.57 for DiGi, based on three “buy” calls, 13 “neutral” calls and 10 “sell” calls.

The problem is, will DiGi be able to sustain this level of dividends, let alone grow it?

It is no secret that the telecommunications industry is dealing with substantial headwinds at the moment. Nonetheless, DiGi still paid out 99% of its earnings as dividends in FY2015, at 22 sen per share. This is just a shade lower than the 100% payout in FY2014.

However, in absolute terms, the dividend was down 14.5% year on year, in line with the 15.19% y-o-y fall in net profit in FY2015.

It could be argued that DiGi’s dividends are normalising after a record-high payout in FY2014 of 26 sen a share. Note that the 26.3 sen per share dividend in FY2012 included a special dividend of eight sen a share.

It remains to be seen if DiGi will be able to sustain earnings in FY2016. But if the first quarter is anything to go by, the company is finding its footing.

Although DiGi’s earnings before interest, tax, depreciation and amortisation fell 9.2% y-o-y, they were flat compared with the previous quarter, growing a mere 0.4%. Earnings, however, will not be the biggest worry for investors. Instead, DiGi’s deteriorating balance sheet is a bigger concern. As at end-2015, the telco’s net gearing had shot up to 2.48 times, compared with 0.76 times a year ago. This was because net debt had increased 147.2% to RM1.29 billion during this period.

As at March 31, 2016, DiGi’s net gearing had eased to 2.1 times, with a net debt of RM1.13 billion.

Increased capital expenditure over the past few years has been the cause of the group’s increasing indebtedness.  Back in FY2011, DiGi was actually a net-cash company with a surplus of RM370 million.

It is important to note that while DiGi’s net debt is substantially higher, it is nowhere near unhealthy levels yet because of the telco’s strong cash flow.

In fact, interest costs in FY2015 were relatively low, at only RM51.54 million. While this is substantially higher than FY2014’s RM33.52 million, it is well covered by operating cash flow — at almost 40.34 times.

This approach certainly works when DiGi enjoys revenue and Ebitda growth every year. But it may not be as sustainable if earnings stagnate or contract.

If profit remains unchanged in FY2016 and DiGi maintains its dividend and capex spending, the company’s net debt would increase by an estimated RM500 million. This would, in turn, increase net gearing to 3.7 times, based on back-of-envelope calculations.

Nonetheless, DiGi CEO Albern Murty has made it clear that he plans to maintain dividends at the current level. He also does not want to cut back on capex at this critical juncture.

“If we don’t start the transformation now, then we will face the challenging situation that you are asking about. Our plan is not to get to that point,” he tells The Edge.

Even in the worst-case scenario, Murthy says, DiGi will maintain its 80% dividend payout policy. Of course, if profits take a heavy beating, a high payout ratio will not be impressive.

All things considered, consensus may have the right idea as it appears the risk for DiGi is on the downside, with no major upside catalysts in sight. This is not a very good value proposition for short-term investors.

Looking ahead, however, it is important to note that DiGi’s balance sheet still gives Murty a year or two of breathing space to find new sources of income to reinvigorate growth for the company.

Present valuations may still be a little high to take this position, but as the share price continues to trend downwards, value will emerge for long-term investors who buy into Murty’s ambition to transform DiGi into an “internet company”.

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