This article first appeared in The Edge Financial Daily on September 20, 2019

Telekom Malaysia Bhd
(Sept 19, RM3.52)
Maintain outperform with an unchanged target price (TP) of RM3.95: Telekom Malaysia Bhd’s revenue for its first half of financial year 2019 (1HFY19) declined 4% year-on-year (y-o-y), mainly due to lower voice and Internet demand (fewer Streamyx subscribers but buffered a growing Unifi base). We believe the guidance for a low to mid-single digit decline in FY19 should still hold, as demand for the group’s main products will likely be weaker on stiffer competition. With new rates being offered since September 2019, heeding the government’s call to make Internet more assessable, it will be interesting to see consumer response to the brand.

However, this could dent average revenue per user (Arpu) numbers in the second half of 2019 (2H19) (versus the second quarter of 2019 when Streamyx was offered at RM86 and Unifi at RM177). That said, the commissioning of customer projects in 2H19 could offer some revenue support.

Yield from the group’s performance improvement plan should continue to trickle into 2HFY19 results, albeit at a lower rate than 1HFY19 due to the operations being traditionally back-loaded. Recall that the group registered operating expenditure (opex) improvements of 11% in 1HFY19, which translated into earnings before interest and tax (Ebit) of RM777.9 million (+75% y-o-y) and margin of 14% (+6.3 percentage points). We are banking on margins to persist at this robust level, but caution that 2H19 projects could undermine direct costs. In the meantime, the compressed Arpu could also contribute to weaker margins, but we believe it would be highly unlikely for the group to miss its FY19 Ebit guidance of being better than FY18.

Market has been abuzz on the recent news that the group is looking to venture aggressively into the mobile segment. We believe a likely hurdle to this implementation could be the upcoming assignment by the Malaysian Communications and Multimedia Commission (MCMC) of the 700 megahertz (MHz), 2300MHz and 2600MHz spectrums by 2H20. However, the mobile business is not an entirely new venture for Telekom as it has been ongoing since January 2018.

Also, during the recent MCMC public inquiry, the group expressed its suitability to be allocated the entire spectrum blocks to facilitate 5G in the future, because of its extensive nationwide fibre coverage. However, reiterating views from our Sept 10 sector report “Spectrum Inquiry; The Word is Out”, we believe that condensing spectrum licences may not make the most commercial sense as it does not give other operators equal ground to experiment the most efficient use of the spectrums. Additionally, monopolistic issues may arise.

Our TP, based on a weighted average capital cost of 9.5% and terminal growth rate of 1.5% implies an enterprise value to forward earnings before interest, taxes, depreciation and amortisation of 5.5 times against our FY20E earnings, with no change to our FY19E/FY20E assumptions in this note. We had earlier rerated the stock from “market perform” in our abovementioned sector update. Reiterating our call premise, we believe Telekom’s share price weakness following its management’s intention to move aggressively into the mobile segment could be overdone. Any loss of cost savings could be exaggerated as its existing mobile business has been operational since January 2018, and granted the scale, it may not incur as significant amount in start-up costs.

Risks to our call include weaker-than-expected voice and Internet demand; stronger-than-expected opex; and stiffer competition. — Kenanga Research, Sept 19