Take a long-term view on Axiata

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This article first appeared in Corporate, The Edge Malaysia Weekly, on September 19 - 25, 2016.


OVER the years, Axiata Group Bhd has gained a sizeable foothold in the emerging markets of Sri Lanka, Bangladesh, Cambodia, India and most recently Nepal. Unlike telcos in developed markets, these investments have huge potential for growth if given time to mature.

However, investors are more focused on the challenges Axiata is facing on the home front, which contributed 65.3% of normalised net profit in 1H2016.

This year alone, Celcom’s normalised net profit fell 25.4% due to stiff competition, and the outlook moving forward is not much better. The Telekom Malaysia Bhd-backed webe will debut later this year and the recent spectrum reallocation exercise will strengthen other competitors like DiGi.Com Bhd and U Mobile Sdn Bhd next year.

Against this backdrop, Axiata has trimmed its dividend this year to keep its capital expenditure (capex) plans on track. Subsequently, there were reports last week that Axiata plans to raise US$700 million in cash by reducing its holdings in some foreign operations.

There seems to be little risk on the upside for Axiata, between the lower dividend and the uncertainty over its investments abroad — the so-called engine of growth.

Axiata last month declared an interim dividend of five sen per share, down from eight sen previously. If the company maintains its final dividend at 12 sen per share, that would give a total dividend payout of 17 sen, down 15% from the previous year.

Since most telcos have been labelled dividend stocks, the reduction of the dividend has put some selling pressure on Axiata’s share price, which has fallen 12.6% year on year (y-o-y) to close at RM5.32 last week.

That works out to a dividend yield of only 3.2%. In fact, some analysts are concerned about further dividend cuts if its earnings continue to underperform.

While there do not appear to be any catalysts in the immediate future, some might argue that the company’s long-term growth prospects are still promising — even if they come with additional risk.

For starters, the weaker dividend is not necessarily a deal-breaker. Unlike its peers, DiGi.Com Bhd and Maxis Bhd, Axiata is not a pure dividend yield counter.

Axiata has a growth story to sell as well. Investors tend to downplay the group’s foreign investments since contributions from these businesses have been slow.

Yet, it is important to keep in mind that these are some of the most populous countries in the world. As these markets mature and develop, so will Axiata’s investments.

Recall that Axiata has a 66.4% stake in PT XL Axiata Tbk in Indonesia that serves 42 million subscribers. It also has 19.8% equity interest in India-based Idea Cellular Ltd that serves a whopping 172 million subscribers.

In Bangladesh, Axiata’s 91.59%-controlled Robi Axiata Ltd serves 28.3 million subscribers. And a proposed merger with Airtel Bangladesh Ltd that is underway will transform it into the second largest player in the country with 40 million customers.

The merger received clearance to proceed from the Bangladeshi High Court last month and it is expected to be completed by the fourth quarter. Axiata will hold a 68.75% stake in the Robi-Airtel telco post-merger.

Axiata also has an 83.32% stake in Sri Lanka’s largest mobile operator, Dialog Axiata Plc, that serves 10.9 million subscribers. In Cambodia, 95.3%-controlled Smart Axiata Co Ltd serves 7.6 million subscribers and the recently concluded 80% acquisition of Ncell Private Ltd gives Axiata another 13 million subscribers in Nepal.

Top these off with its 28.32% stake in Singapore’s M1 Ltd, which has 2.06 million customers, and Axiata is one of the largest and most diversified telcos in Asia in terms of population coverage.

Some investment analysts do not find that attractive, simply because Axiata needs to pour in a lot of money before this large pool of subscribers generates the desired profit.

Axiata has already spent RM2.29 billion in capex in the first half of this year and is expected to spend RM5.7 billion for the full year.

Hence, the lower dividend is not necessarily a bad thing for shareholders for the sake of financial prudence. While existing shareholders have certainly taken a hit, the reduction underlines management’s focus on cultivating future growth. Furthermore, the dividend cut may refute the speculation that Axiata is under pressure to pay dividends because its controlling shareholder, Khazanah Nasional Bhd, needs to contribute to the nation’s coffers.

Sure, the one-off spectrum fee of RM817 million this year did put some additional stress on the group’s cash flow, but rather than increasing borrowings to pay a dividend, the management opted for the more prudent path.

It is interesting to note that the bulk of the capex has been focused on Indonesia’s XL and Bangladesh’s Robi. Year to date, RM796 million has been invested in XL and RM582 million in Robi. In contrast, Celcom’s capex was RM446 million.

At the same time, Indonesia-listed XL has also been one of the worst performing for Axiata in terms of earnings contribution. One reason is the costly but necessary shift from legacy services to data. Telcos in Malaysia went through a similar challenge.

Despite some signs of improvement in XL, like the 22.4% growth in data usage and a 9.8% growth in earnings before interest, taxes, depreciation and amortisation (Ebitda), XL’s share price remains depressed at IDR2,660 — near its all-time lows.

Between the high investment and low valuation for XL, it seems highly unlikely that Axiata would trim its holdings in the Indonesian outfit at this juncture.

Nonetheless, a news report last week said Axiata was planning to dispose of 11% of its stake in XL. In addition, the report said Axiata would also dispose of a 30% stake in Sri Langka’s Dialog Axiata Plc, and 30% of Smart Axiata Co in Cambodia.

If Axiata actually sells out of XL at this stage, it would raise some serious concerns about the group’s balance sheet and its investment.

Based on Axiata’s current gearing, however, that is unlikely. The acquisition of Ncell has lifted Axiata’s gross debt-to-Ebitda of 2.46 times and net debt-to-Ebitda of 1.53 times. While there is not much headroom, it is still within the 2.5 times gross debt-to-Ebitda ceiling that would concern ratings agencies. Note that Axiata has over RM8 billion in cash on hand.

Moody’s on Sept 1 maintained Axiata’s long-term Baa2 rating.

“Leverage increased to 2.7 times in 1H2016 from 2.3 times in December 2015 — primarily a result of its partial debt-funded acquisition of Ncell in April 2016,” Moody’s report says.

Furthermore, Moody’s expects Axiata’s gross gearing to return to 2.3 times over the next 12 months, “when considering a full-year contribution from Ncell and steady growth in Axiata’s key markets”.

This does not take into account the disposal of assets.

Axiata is still expected to reduce its gearing. However, it is not in such a dire situation that would force it to sell off immature assets like XL. In fact, the group has a myriad of options to explore, including a rights issue and perpetual sukuk.

Another way to look at it is that Axiata has expanded as much as its balance sheet will allow at present. Without a cash call, the group will have to recycle some of its capital to fund new acquisitions.

One example of this is the planned listing of edotco (M) Sdn Bhd, a tower leasing company.

Such asset monetisation is unrelated to capex spending. Capex has to compete with dividend payments from the group’s Ebitda. The good news is, Ebitda grew by 14% y-o-y in 1H2016.

Net profit, however, is expected to lag as high capex will also translate into higher depreciation and amortisation costs.

In summary, Axiata will not be able to pay high dividends, nor deliver strong earnings growth, in the near term as competition in Malaysia puts pressure on Celcom’s earnings.

However, if Axiata’s share price continues to slide, it will present an opportunity to buy cheaply into one of the largest diversified emerging market telcos.