The telecommunications (telco) sector is expected to face difficult headwinds given the heightened regulatory pressure and competition that is unlikely to abate anytime soon, said PublicInvest Research analyst Eltricia Foong.
“We reckon that the operating landscape for both mobile and fixed-line operators will continue to be challenging. In the past, the fixed-line broadband market had been nonchalant but with the implementation of Mandatory Standard on Access Pricing (MSAP) following the change of federal government in May, this segment has since been hit by lower margin and greater competition,” she said in her report.
With the implementation of MSAP, wholesale prices for network services are expected to be reduced by 8.7% to 12.1% between 2018 and 2020 while retail broadband prices are expected to decline 25% by end-2018.
Although Telekom Malaysia (TM) currently monopolises the fixed-line fibre network, lower wholesale prices and the possible opening of its fibre network could mean greater competition in the future.
Foong said the mobile segment has gone through a price war in recent years but judging from the relatively high profit margins enjoyed by operators, she believes that there is still room for further decline in prices, noting the risk of the regulator pressing for lower prices in the future.
“We note that the mobile industry has been hit by price competition in recent years, particularly the postpaid segment where average revenue per unit (Arpu) has declined from a high of RM91 in 2013 to RM86 currently. Interestingly, prepaid Arpu has been holding up at around RM36 during the same period, though competition had temporarily brought down the rate to RM32 in 2016,” she said.
She noted that Digi was hit the most, as its prepaid pricing was reduced from about RM40 in 2013 to RM32 currently.
Operators in Malaysia continue to enjoy higher profit margin relative to regional peers, with net margins of between 10% and 24%. In Thailand, Indonesia and Singapore, operators’ net margins are between 2% and 20%.
While the price competition that started in 2015 has led to lower profit for most telco players, Foong said, overall Arpu is not likely to improve but instead, may continue its downtrend, either due to market forces or regulatory pressure.
“In an environment of falling revenues, cost optimisation will be the key for players to strive in this challenging telco industry. Digi and Maxis have proven track records in cost management while TM and Axiata are high-cost operators. This could also mean that there is limited scope for Digi and Maxis to extract greater cost efficiency going forward,” she said.
For TM, the MSAP would result in lower revenue for its wholesale business and lower Arpu for Unifi services, and it is crucial for TM to achieve better cost efficiency in order to cushion the impact of further margin erosion.
Foong said TM has the highest manpower cost as a percentage of revenue at 22% in FY17, compared to under 10% for the mobile operators. Although its high proportion of staff cost is justifiable with its extensive backhaul infrastructure, it is still lagging in terms of achieving optimal level of productivity.
“Measured against revenue per employee, TM has the lowest count of RM500,000. Generally, we feel that any staff downsizing measures by TM would be costly and perhaps sensitive given the presence of labour union,” she said.
Other costs that TM could potentially rationalise are supplies and materials, and maintenance costs.
Given the weak prospect of declining revenue while cost rationalisation may be an uphill challenge for TM, Foong does not rule the possibility of TM being privatised in the future, which may make it easier for TM to restructure its operations.
However, a merger between TM and Axiata is unlikely to materialise as the differences in corporate culture would impede a smooth integration process.
Operators with good management track records like Digi and Maxis could still leverage on cost efficiency to minimise earnings decline in the near term, though the scope to do so is limited.
Meanwhile, the less cost-efficient operators are likely to post a more significant drop in earnings in an environment of declining revenue, which would jeopardise their ability to maintain their historical dividend payout.
“Prior to the onslaught of price competition in 2015, the telco sector had been paying attractive dividend but this has since deteriorated over the years. Between 2014 and 2019, our projected DPS CAGR for the sector is -12%.
“In view of the unexciting earnings growth prospects, higher operating risk and lower dividend, we downgrade the telco sector to ‘underweight’. We cut our Arpu assumptions for FY19-20F for all the mobile operators and reduce terminal growth to 1.5%,” said Foong.
