We remain UNDERWEIGHT on the Malaysian telecoms space due to the sector’s demanding valuations,  vis-à-vis its regional peers. Valuations have seen new heights in the last two years due to the combination of a benign  competitive  environment  and  compression  in  bond  yields. Nonetheless,  we  think  stocks  which  offer  better  revenue  growth potential (such as Telekom Malaysia) could fare better.

• Valuations  at  a  new  plateau.  The  mobile  operators’  forward  P/E multiples have trended higher from the mid-  to high-teens level to about 20-25x  currently.  The  competitive  environment  has  been  relatively benign in the last two years, as mobile operators have managed to keep their operating metrics (EBITDA margin, blended ARPUs, market share) relatively stable.
• But we see some risk.  The compression of the Malaysian Government Securities (MGS) yield (using the 10-year tenure bond as a guide)  have contrived  to  push  valuations  higher  given  the  generous  dividends  paid out by mobile operators, in particular Maxis. We think a reversal of this trend may have a potential negative impact on valuations.
• Competitive  landscape  unlikely  to  change  significantly.  The competitive landscape  is  unlikely  to  change materially going forward, in our view. The WiMAX players are still struggling to generate profits  and thus  will  not  likely  cause  too  much  ripples  in  the  market,  in  our  view. Given  their  heavy  reliance  on  mobile  broadband  for  the  bulk  of  their revenue,  we  believe  they  may  continue  to  struggle  moving  forward, unlike  the  mobile operators who can fall back on their traditional voice and SMS segments.
• Market  maturity  a  likely  cause  for  benign  competition.  We  believe the  relatively  benign  competition  is  partly  due  to  an  increasingly saturated mobile market. Mobile operators’ sequential quarterly revenue growth has been quite modest (averaging just 1-2%), which we believe is a reflection of market maturity
• Outlook.  Overall,  we  expect  industry  revenue  growth  to  moderate  to 4.6% in  2014  from 5.6%  in 2013. We  note  that  SMS  is  facing  notable cannibalisation  from  substitution  to  data.  This  implies  industry  revenue growth will likely moderate in 2014, unless data monetisation turns more effective  and  successful.  We  believe  sensible  data  pricing  is  key  to ensure that data is monetised properly going forward.
• Maintain  UNDERWEIGHT  on  sector.  With  no  further  expectations  of tax  incentives  after  their  expiry  in  3Q13,  we  believe  the  chances  of positive earnings surprises in 2014 will be minimal. We still like Axiata for a potential turnaround in XL (EXCL IJ, NEUTRAL, FV: IDR4600), which should spur a rebound in its FY14 earnings growth.

Catalysts still some distance away 
We remain  UNDERWEIGHT  on  the  Malaysian  telecoms  space due  to  the sector’s demanding  valuations,  vis-à-vis  its  regional  peers.  While  we  believe  the  sector’s fundamentals remain sound, the telcos are facing headwinds in monetising da ta withtraditional SMS revenue under threat.

The notable highlights during 3Q13 were: i) a marked erosion in SMS revenue, and ii) the  presence  of  tax  incentives  that  boosted  earnings.  In  the  fixed  line  industry, Telekom  Malaysia  (T  MK,  NEUTRAL,  TP:  MYR5.50),  or  TM,  continues  to  execute well on UniFi, although Maxis  (MAXIS MK, SELL, TP: MYR5.90) managed to capture a slightly higher share of the industry net additions in 3Q13. There is no change to our recommendations on the stocks.

While  we  view  the  implementation  of  the  6%  goods  and  services  tax  (GST)  as  a potential  re-rating  catalyst  for  the  sector,  we  note  that  its  implementation  will  only take place in April 2015. Hence, we believe the market will likely price in the positive earnings impact of passing on the prepaid service tax to consumers as we approach 2H14.

DiGi  (DIGI  MK,  SELL,  TP:  MYR4.10)  is  seen  to  be  the  biggest  beneficiary,  as  we estimate about 65.0% of its revenue comes from prepaid users, followed by Celcom (50.0%) and Maxis (45.0%). Our scenario analysis indicates sharp rises in our FVs for  the  mobile  players,  if  the  6.0%  service  tax  is  no  longer  absorbed:  i)  DiGi (+MYR0.60  to  MYR4.70),  ii)  Axiata  (+MYR0.45  to  MYR7.00),  and  iii)  Maxis (+MYR0.50  to  MYR6.40),  mainly  due  to  the  significant  earnings  boost  (10-15%  in FY15).

Valuations at new plateau but face risks
Telecom valuations have seen new heights in the last two years due to a combination of  a  benign  competitive  environment  as  well  as  compression  in  bond  yields.  The mobile operators’  forward P/E  multiples have trended higher from the mid-  to  highteens level to about 20-25x currently. Nonetheless, we think stocks which offer better revenue  growth  potential (such as TM)  could  still  fare better. Stocks  that  have seen their  dividend  yields  compressed  (such  as  Maxis)  may  struggle  amid  rising  bond yields, given that the US Federal Reserve is trimming i ts monthly bond purchases to USD75bn from USD85bn.

The competitive environment has been relatively benign in the last two years, in our view.  As  seen  in  the  charts  below,  mobile  operators  have  managed  to  keep  their operating metrics relatively stable: i) EBITDA margins have been resilient, ii) blended ARPUs have held up as voice erosion was not as bad as previously feared, and iii) Maxis  lost  a  bit  of  its  market  share  due  to  some  complacency  in  prepaid  but  this could  reverse  with  its  new  CEO,  Morten  Lundal,  on  board.  Unsurprisingly, shareholders have been rewarded with generous dividends.

The compression of the MGS yield (using the 10-year tenure bond as a  guide)  may have  also  acted to push valuations higher given the generous dividends paid out  by mobile operators, in particular Maxis.  We think a reversal of this trend may have a potential negative impact on valuations.

Competitive landscape unlikely to change significantly 
The competitive landscape is unlikely to change materially going forward, in our view. The  WiMAX  players  are  still  struggling  to  generate  profits  and  thus  will  not  likely cause  too  much  ripples  in  the  market,  in  our  view.  Given  their  heavy  reliance  on mobile  broadband  for  the  bulk  of  their  revenue,  we  believe  they  may  continue  to struggle,  unlike the mobile operators who can fall back on their  traditional voice and SMS segments (which command better margins).

Green Packet is  one of WiMAX players  who has been  in the market  the longest, but has yet to make a profit. Meanwhile, YTL Communications SB (YTL Comms) entered the  mobile  broadband  market  with  its  WiMAX  network   in  early  2011,  but  has  not significantly altered the competitive landscape, in our view.

The successful launch and execution of the high-speed broadband (HSBB) network by TM also meant that the appeal of mobile broadband (which is WiMAX players’ key focus)  has  been  restricted  to  a  declining  number  of  users  requiring  true  Internet mobility,  as  more  consumers  become  increasingly  content  with  the  proliferation  of fast WiFi.

Market maturity a likely cause for benign competition
We believe the relatively benign competition is partly due to an increasingly saturated mobile market, which implied that any aggressive price cuts may not yield significant accretion  to  subscriber  and  voice  usage  growth.  The  relatively  benign  competitive environment  does  not  mean  that  the  mobile  operators  are  seeing  high  sequential revenue  growth. Instead,  it has  been quite  modest (averaging just 1-2%), which we believe is a reflection of market maturity.

We note that Maxis made some  downward  price adjustments  in 2012, but we view these  as measures to  mitigate further erosion in Maxis’ subscriber market share by bringing  its  pricing  closer  to  its  peers  rather  that  outright  price  undercutting.  Going forward, Maxis does not expect to make  further significant price adjustments as it did in 2012. Instead, it will be working on improving its distribution network and branding, which could result in an uptick in spending on advertising and promotion.

Pockets of earnings growth recovery in 2014 
Overall, we expect industry revenue growth to moderate to 4.6% in 2014  from 5.6% in  2013. We  note  that  SMS  is  facing  notable  cannibalisation  from  substitution  into data.  SMS  revenue  has  been  relatively  flat  following  the  restriction  on  mobile operators  from  selling  bulk  SMS  since  March  2012.  However,  with  smartphone adoption and over-the-top usage rising, the sequential q-o-q decline (approximately mid-single digit) in SMS revenue has been quite noticeable in 2013.

Source: RHB