Telcos fared well in recent selldown

Written by Insider Asia    Friday, 23 September 2011 14:17 With investors scrambling in the selloff amid rising uncertainties in global financial markets, stock yields are holding up comparatively well. Telecommunications in particular is widely seen as one of the most defensive sectors to invest in currently. Revenue for telcos is expected to be fairly resilient even in the face of weaker consumer spending as confidence wanes. Indeed, given our lifestyles today, telco services are more a necessity than discretionary spending. This translates into sustainable cash flow and dividend payouts. Despite the continuous capital spending requirements, free cash flow generated from telco operations remains by and large robust. Thus, most telcos maintain a generous dividend payout. Even if expectations for growth and capital appreciation are limited, investors seek out these stocks for their higher than market average yields. Keeping a portion of a diversified portfolio in high-yielding stocks may not be a bad strategy, especially in the near to medium term, until there are clearer indications on the market direction going into 2012. It is hard to predict when the global economy and asset prices will turn around after the current volatility subsides. Holding cash generates zero returns while bank deposit rates are historically low. DiGi and Maxis shares have outperformed If historical performance is any guide, DiGi.Com Bhd and Maxis Bhd’s shares have outperformed the FBM KLCI, the benchmark index for the local bourse, year-to-date. DiGi’s stock has done particularly well. Even though the company’s 2011/12 earnings will be hit by accelerated depreciation charges, its underlying business is faring well in a highly competitive environment. The company registered the strongest subscriber growth in 1H11 among the big three mobile operators, that include Maxis and Celcom Bhd, albeit from the smallest base. Revenue for the first six months was up 10.4% year-on-year (y-o-y), well above the industry average of 3%. DiGi is upbeat that it can maintain a high single digit pace of growth for the full-year. The solid top line growth and economies of scale bolstered operating margins. Earnings before interest, tax, depreciation and amortisation (Ebitda) margin averaged 45.9% in 1H11, up from the average operating margin of  44.4% in 2010. The company intends to improve its profitability further through a combination of market share gain, cost savings and improved network efficiency. These include savings on operational expenditure and capital expenditure from its ongoing collaboration with Celcom, to consolidate and upgrade their telecommunication sites and transmission network. Maxis’ earnings likely to remain flattish in 2011/12 Maxis had the slowest subscriber addition in 2QFY11, by just 13,000. The total subscriber count was distorted in 1QFY11 due to a tightening of its definition of an active user. Nonetheless, the company remains the largest mobile operator in the country with 12.76 million subscribers or about 38% of the market. Total revenue for 1HFY11 contracted by 1.2% y-o-y. This is due primarily to the company’s decision to scale back operations at the low margin international gateway unit. Excluding contributions from international gateway, Maxis’ revenue grew, but by a rather pedestrian 1.5% y-o-y. Net profit was up some 0.6% over the same period. We expect earnings to contract slightly for 2011/12, after taking into account the higher costs to be incurred with the company’s entry into the high-speed home broadband market segment, in 2HFY11. Recall that Maxis signed a 10-year agreement for wholesale high-speed broadband (HSBB) services from Telekom Malaysia Bhd late last year. This would give it instant access to a potential market of 1.1 million households by end-2011 and 1.3 million by next year on top of its own fibre network, primarily to multi-dwelling units. Home broadband services will be loss-making in the initial years Maxis singled out high-speed home broadband services as one of the key growth drivers over the longer term. While competition will be intense with Streamyx, P1, Unifi and new entrant, Celcom, jostling for market share, there is growing demand for faster broadband. The most efficient delivery channel for HSBB content is through the fibre network. In addition to “plain vanilla” Internet access, Maxis is aiming to offer a range of value added services, including VoIP, IPTV, video-on-demand and so on. In this respect, the company has the upper hand. It can piggyback on sister company Astro All Asia Networks plc’s already expansive content. Nevertheless, the home services business will be loss-making for several years, until the subscriber base hits the estimated breakeven point of one million. For now, growth from mobile Internet and mobile broadband will have to pick up the slack from declining voice revenue. Maxis expects to maintain 40 sen per share dividends On balance, capital gains for Maxis over the next two years may be limited. But high dividend payout will provide support to its share price and capital preservation for investors. We estimate dividends to remain at last year’s level of 40 sen per share, giving shareholders an attractive net yield of 7.5%. Further growth in total industry subscribers will taper off with penetration rate having exceeded 100% of population. But the slight uptick in average revenue per user (ARPU) in 2QFY11 for Maxis bodes well. The increasing proliferation and gradual migration towards smartphones, which typically come bundled with higher value voice-cum-data plans, should help stabilise, and may even reverse, the downtrend in ARPU. DiGi may raise payout with second capital management exercise in 2012 Assuming 100% profit payout plus the recently proposed capital repayment of RM509 million, dividends for DiGi are estimated to total about RM3.44 per share for 2011/12. If distributed equally over the two years, shareholders will earn net yields of 5.7% per year. Although this is lower than the expected yield from Maxis, DiGi’s outlook for capital gains is better, taking into account the company’s current pace of growth and strategies put in place for margin improvements. Plus, management has hinted at a second capital management exercise. DiGi has a much stronger balance sheet with gearing of just 5% as at end-June 2011, compared with Maxis’ 53%. That leaves it with more room to return excess cash to shareholders. Some market observers speculate that up to 89 sen per share worth of future capital distribution is possible based on the company’s current balance sheet. DiGi recently proposed a one-to-10 share split, which is expected to be completed by 4QFY11. Although the move will have no impact on earnings, the lower adjusted share price will make the stock more affordable, especially to retail investors. Note: This report is brought to you by Asia Analytica Sdn Bhd, a licensed investment adviser. Please exercise your own judgment or seek professional advice for your specific investment needs. We are not responsible for your investment decisions. Our shareholders, directors and employees may have positions in any of the stocks mentioned. This article appeared in The Edge Financial Daily, September 23, 2011.