Macquarie Equities Research (MQ Research) released a report last Friday (23 Nov), stating that the shares of telecommunications company Telekom Malaysia (TM) are undervalued and reflect very negative regulatory outcomes in the long run. MQ Research reiterates their Outperform recommendation on TM with a price target of RM5.40, more than double the current share price of RM2.33.

Conclusion

• MQ Research reiterates their Outperform recommendation on Telekom Malaysia (TM) with an unchanged price target of RM5.40, as they believe its shares are undervalued and reflect very negative regulatory outcomes in the long run. MQ Research believes that as clarity on the regulatory front, in particular how the government plans to achieve its national fibre agenda, are detailed, there will be a significant rerating of TM’s shares which trade at 4.9x EV/EBITDA or 1.1x price to book (PB).

Impact

• Undervalued network. While TM’s 1.1x PB valuation would imply a premium to book, the market is clearly ignoring the replacement value of TM’s network. According to its 2017 annual report, TM had RM27bn (RM7.14/sh) worth of assets which were fully depreciated but still in use – largely its copper network, ducts and poles. While the copper network will be phased out over time as it is replaced with fiber, the ducts and poles are clearly a valuable and not easily (nor cheaply) replicated infrastructure. Adding half of these fully depreciated assets to TM’s book value would imply a P/B ratio of 0.4x.
• Cashflows healthy even if average revenue per user (ARPU) fell a further RM20/month. By MQ Research’s estimates, TM would still generate a 3% free cash flow (FCF) yield in 2019 if ARPUs on its entire broadband product suite fell a further RM20/month from their current estimates of RM164 for Unifi and RM90 for Streamyx. As its cost-out initiatives take effect, FCF yields would rise to >10% by 2020, by MQ Research’s estimates.
• Cost-outs in the medium term. MQ Research’s forecasts remain 8% and 44% below consensus in FY18 and FY19, respectively, as they expect cost reductions to take time to flow through. In addition to the ongoing efforts to trim costs MQ Research believes shutting down the mobility element of its wireless business could bring the biggest cost-savings. According to company disclosures, TM paid Celcom RM277m between May 2017-Feb 2018 (or annualised at RM332m) for roaming charges vs Webe’s total (including fixed wireless services) reported revenues of RM320m in 2017, suggesting the mobility business is not even covering its roaming costs.

Earnings and Target Price Revision

• No change.

Price Catalyst

• 12-month price target: RM5.40 based on a discounted cash flow (DCF) methodology.
• Catalyst: Clarification on funding of fibre roll outs.

Action and Recommendation

• Outperform maintained.

Source: Macquarie Research - 26 Nov 2018