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Saturday, 24 June 2017

(The Star) Growth challenges of telcos

Telecommunication companies find limited room to grow as the market matures

Telecommunication companies (telcos) are often favoured for their resilient business models and the attractive dividend yields the shares of those companies offer.

But with the domestic market now approaching maturity and growth prospects moderating, and earnings coming under pressure from intense competition and rising costs, local telcos have seen their resilience increasingly being put to the test. They have limited options, therefore, but to seek new avenues to expand their revenues and profit.

And like it or not, this often involves the need to increase their spending on capital expenditure (capex) investment - which will certainly exacerbate costs - to upgrade their infrastructure, enhance their service quality and develop new products to meet the changing trends in consumer demands in order to stay relevant and competitive in the business.

For some telcos, the sustainability of high dividend payouts, which represent the percentage of cash returns to shareholders over the company’s earnings, have come into question because of their need to adapt to the evolving industry landscape.

Take the case of Maxis Bhd and Axiata Group Bhd.

Maxis, which over the week announced a private placement exercise to raise up to RM1.7bil to strengthen its financial position and give it the flexibility to fund the group’s future spectrum fees and growth strategy, had its dividend payout ratio cut down to 75% since last year from 86% in 2015 and more than 100% through 2010-2014.

Axiata, on the other hand, had said it would maintain a lower dividend policy this year after cutting its dividend payout to 50% last year from 85% in the preceding year. The move, the company’s management says, is a short-term strategy to conserve capital to its finance future growth.

While some analysts have recently raised concerns over the potential for further cuts in dividend by some telcos, a lower dividend policy, according to a fund manager with a local brokerage, is not necessarily a bad thing.

“Yes, a cut in dividend will pose downside risk to the company’s share price, but lower dividend payout ratios are sometimes considered healthier for telcos, as they allow more cash to be used for operating activities and business expansion... in this industry, capex is necessary to maintain the business,” the fund manager tells StarBizWeek.

“No doubt, higher payout ratios, which allow for higher dividends, are often sought by income investors, but these can sometimes put constraints to the future growth of the telco,” he says, adding that very high dividend payout ratios, especially those exceeding 100%, can sometimes be interpreted as an indication of diminishing growth prospects for the company.

Less appealing

Among the local telcos, only Telekom Malaysia Bhd (TM) and DiGi.Com Bhd at present still maintain dividend payout ratios of at least 100%.

In terms of dividend yields, commonly used to gauge a stock’s potential return, DiGi leads with more than 4%, while Maxis and TM offer around 3.5% and 3.2%, respectively, while that of Axiata and Time dotCom stand at about 1%.

For some fund managers, though, Malaysian telcos in general are appearing less appealing now.

Areca Capital CEO Danny Wong, for one, considers it a “high risk” sector, given the unpredictable cost structure and the tight competition environment in which the telcos, especially those in the mobile space, operate.

“We think the risk is high at its present state due to the unpredictable cost structure and very dynamic market environment,” Wong says, pointing out that telcos in Malaysia operate under very strict licensing rule.

“There is very limited upside to growth for most telcos, and once high cost kicks in for them, dividend payouts could be affected. In that sense, they could lose some of their defensive qualities,” he adds.

Wong concedes that telcos is one of the few sectors that he currently avoids having in his investment portfolio.

Similarly lamenting that the industry is “not as great as it used to be”, Aberdeen Asset Management Sdn Bhd managing director Gerald Ambrose says, “it has become increasingly difficult to gauge the prospects of the industry.”

For one thing, he notes, intense competition leading to ongoing price wars among telcos in the mobile space such as Maxis, DiGi.Com Bhd and Celcom Axiata Bhd has posed a challenge to growth in the industry.

In the first three months of 2017, for instance, Maxis, DiGi and Celcom continued to see declining number of subscribers, which resulted in their revenue contraction, while ongoing price wars as the players attempted to defend their market share suppressed margins.

In addition, Ambrose says, the telco industry evolves far too quickly and continuously requires a lot of capex in order to generate future revenue growth and profitability.

According to an industry observer, expansion in fibre-optic infrastructure for high-speed broadband and investments in long-term evolution capability for high-speed mobile communications are expected to capex in the telco industry.

For mobile operators, in particular, the re-pricing and re-allocation of the 700MHz, 2100MHz and 2600MHz spectrum between the end of this year and 2018 could result in higher spectrum costs.

An estimate by Maybank Investment Bank (MIB) Research put the upfront portion of the 700MHz, 2100MHz and 2600MHz spectrum fees at total around RM1.2bil per operator, while another industry estimate expect mobile operators to spend anything from RM800mil to RM1.3bil a year on upgrades.

As it stands, most analysts have ascribed a “neutral” rating on Malaysian telcos in view of their lacklustre growth prospects this year and relatively expensive valuations.

Axiata, which is expanding into emerging and frontier markets with relatively low mobile penetration rate such as Nepal and Bangladesh as well as into the telecommunications tower business as new engines of growth, is currently trading at around 43 times its estimated earnings for 2017.

The counter closed unchanged yesterday at RM4.94.

A Bloomberg poll shows there are only five “buy” calls on Axiata, against 21 “hold” and three “sell” calls on the counter, with a median target price of RM4.90. Some analysts nevertheless expect the potential re-merger of Axiata and TM to be a re-rating catalyst that could generate investor interest in both the counters.

TM, which is rated with 15 “buy”, 11 “hold” and three “sell” calls, with a median target price of RM6.88, is currently trading at about 30 times its estimated earnings for 2017. The counter gained two sen to close at RM6.62 yesterday.

Meanwhile, Time dotCom is trading at 23 times its estimated earnings for this year, while Maxis and DiGi are trading at around 22 and 24 times their estimated earnings for 2017, respectively.

Bloomberg’s poll show there are five “buy” and three “hold” calls on Time dotCom, which has been assigned with a median target price of RM9.48.

The counter closed unchanged at RM9.68 yesterday.

Maxis has 15 analysts recommending “hold” and 14 analysts recommending “sell”, with a median target price of RM5.59. Its shares gained five sen to close at RM5.64.

DiGi, on the other hand, closed unchanged at RM4.99 yesterday. The counter has two “buy”, 15 “hold” and 12 “sell” recommendations according to a Bloomberg poll, with a median target price of RM4.72.