Mixed bag of earnings for telcos

March 7, 2017

Upgrade to neutral from overweight: Although the fourth quarter of 2016 (4Q16) results were broadly within expectations, sector earnings declined 24% in 2016 amid weaker revenue and higher costs. The 58% collapse in Axiata Group Bhd’s earnings was a major disappointment.

Meanwhile, Maxis Bhd held up pretty well, operationally, amid shrinking sector revenue. Competition has, however, abated over the past two quarters and been reflected in improved operational performance. Competition, nevertheless, remains a near term key risk.

We raise our sector rating to “neutral” (from “underweight”) after our recent upgrade on Axiata. We still like DiGi for its sector exposure, but Maxis’ resilience is also a compelling reason to own the stock.

To sum it up, Malaysian telecommunications companies (telcos) reported a mixed bag of earnings for 4Q16 but broadly in line with expectations despite the 24% contraction in earnings. Sequentially, earnings contracted 13% due to massive accelerated depreciation charges at Axiata.

At the headline net profit level, Axiata recorded a quarterly net loss hit by foreign exchange losses on its US-dollar loans.

Maxis’ resilience stands out. Operationally, the celcos reported the third consecutive year of decline in revenue and earnings before interest, taxes, depreciation and amortisation (Ebitda). This has been due to competition from unlisted player U Mobile.

Maxis has nevertheless managed to gain revenue share over the past two years. Its new management team (new chief executive officer from late 2013), revamped product/pricing strategy and premium network have started to bear fruit. Surprisingly, despite the competition and the stronger US dollar, sector margins have held up impressively well on cost efficiency and possibly more efficient use of its data network.

Sector earnings are expected to rebound by a sharp 12% in 2017 after the 24% decline in 2016. Excluding Axiata, sector earnings are projected to grow at a more realistic 1%, consistent with the guidance by celcos of flattish revenue and Ebitda levels for 2017.

However, we do not foresee sector earnings returning to the RM7 billion range (2013 to 2015 levels) over the near term dragged by enhanced competition within the celco space and operational losses at webe for Telekom Malaysia.

We recently upgraded Axiata to “hold” (from “sell”) during the reporting and with this, push the sector back to a “neutral” from “underweight”. The sector however lacks any rerating catalyst while valuations are demanding vis-a-vis historical average especially amid increased competition.

Likewise, we think that dividend yield plays are unlikely to outperform in a rising yield environment.

Moreover sector yields at 3% are not too compelling. For sector exposure, our preferred picks are DiGi and Maxis.