This article first appeared in The Edge Financial Daily on September 5, 2019

Telecommunications sector
Maintain overweight: The telecommunications (telco) sector’s second quarter of 2019 (2Q19) results were largely within expectations as normalised earnings of Maxis Bhd and Digi.Com Bhd came in within expectations while Telekom Malaysia Bhd (TM) continued its commendable improvement in its cost structure in which the management reaffirmed did not include any one-off provision write-back.

While Time dotCom Bhd’s (unrated) first half of financial year 2019 (1HFY19) net profit growth of 22% year-on-year (y-o-y) far surpassed its tepid telco peers, this largely came within the market’s sanguine expectations.

TM’s stronger bottom-line delivery stemmed from the low operating costs which continued from 1QFY19, with 1HFY19 operating costs declining by 16% y-o-y to RM3.6 billion. This was driven by the group’s transformative performance improvement programme, an ongoing initiative that has been carried out since mid-2018, driving cost optimisation in content sponsorship costs, contract renegotiations, marketing, business procurement and Unifi mobile’s domestic roaming arrangements.

Recently, the roll-out of the National Fiberisation and Connectivity Plan (NFCP) over a five-year period from this year to 2023 was initiated. The NFCP roll-out could cost RM21.6 billion, of which 50% to 60% may be financed by the Malaysian Communications and Multimedia Commission’s Universal Service Provider fund that currently holds RM8 billion. This is in line with the government’s objective to recognise access to the Internet as a basic right, ensuring equal access to the Internet for both urban and rural residents.

Given TM’s role as the national broadband provider, the group will likely bear up to half of the NFCP cost, which translates into RM2.2 billion over the next five years. Besides TM’s own capital expenditure (capex) requirements, the NFCP roll-out alone translates into 19% of forecast financial year 2020 (FY20F) revenue — already above the management’s FY19F capex target of 18% and 8% in 1HFY19. Additionally, the thrust of the NFCP towards connecting the rural population could mean that revenue accretion from these investments will be minimal.

Cellular operators’ (Celco) 2Q19 net profit rose 14% quarter-on-quarter (q-o-q) to RM1 billion on lower operating costs and lower effective tax rate even though revenue was flattish at RM5.4 billion. This stemmed largely from Celcom’s improved cost discipline and Digi’s lower effective tax rate, although partly offset by the continuing decline in Maxis’ terminated wholesale 3G access arrangement with U-Mobile.

The total subscriber trajectory flipped upwards in 2Q19 after a four-year continuous decline. Mobile subscribers rose 77,000 as postpaid additions of 216,000 had more than offset prepaid contractions of 139,000. Maxis enjoyed the highest net accretions of 136,000, followed by Digi’s 113,000, while Celcom continued to decrease 172,000 from its dwindling prepaid base.

While the prepaid subscriber base continued to dwindle, the higher value postpaid segment grew 216,000 (+2%) q-o-q and 863,000 (+10%) y-o-y to 9.4 million. This is partly offset by an average postpaid average revenue per user (Arpu) declining by RM1 a month q-o-q and y-o-y to RM80 a month.

Maxis remains the revenue leader despite Digi’s larger subscriber base. Digi continued to command the largest subscriber market share at 37% versus Maxis’ 35% while Celcom remained a distant third at 28%. Digi’s pole position since 1Q16 stemmed largely from its strength in the prepaid segment, underpinned by the migrant population.

However, Maxis is strongest in the postpaid segment with an Arpu and subscriber base, which are 23% and 17% respectively higher than Digi’s. This places Maxis in the leading position with a 1H19 revenue market share of 41% versus 31% for Celcom and 28% for Digi.

Rerating catalysts from merger and cost optimisation drives. Prospects for the sector have structurally transformed as a result of the proposed Telenor Asia-Axiata merger as the number of cellular competitors reduces from five to four. The emerging dominant player will be unlikely to initiate further price cuts that will only erode its bottom line

As merger synergies could take at least two years to materialise, Maxis will be free to pursue its converged fiberised solutions for its consumer, enterprise and business segments. Meanwhile, TM’s cost optimisation drives could be reaffirmed over the next few quarters, spurring growing market conviction that will catalyse further revaluation cycles.

We maintain an “overweight” outlook on the sector given the multiple synergies from sector consolidation, which will significantly alleviate price competition that has been eroding the sector’s margins over the past three years.

However, we have lowered our fair value for TM to RM3.50 a share (from RM4.25 a share) by lowering its discounted cash flow terminal growth assumption to 1% from 2%, given the expected escalation in the NFCP-driven capex requirements. — AmInvestment Bank, Sept 4