DIGI – Fundamental Analysis (21 Jul 2015)

About DIGI

This company is involved in the establishment, maintenance and provision of mobile telecommunication services and its related products in Malaysia.

Ownership

Main shareholders of DIGI are Telenor ASA and institutional funds. Besides, DIGI is covered by a lot of local and foreign analysts. This provides quite a good liquidity to this shares.

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Economic Moats

Cost Advantage Moat: Narrow

  • Lower ARPU if compare to MAXIS and CELCOM. However, DIGI got the highest net profit margin.
Switching Costs Moat: None

  • Nowadays, changing Telco is piece of cake. However, good coverage service will retain subscribers longer.
  • DIGI coverage is still not as good as MAXIS and CELCOM, but DIGI makes great efforts to improve their network.
  • Since Jun 2013 (after they upgraded few thousands of stations) , I have much better experience in using their data services, and I am no longer experience call drop while driving.
Network Effect Moat: Narrow

  • DiGi has established an integrated distribution approach across all its owned shops, exclusive stores, dealers and alternate channels. This in-depth cluster performance management structure will assist DiGi in driving prepaid while strengthening its postpaid and broadband.
  • With the stronger organisational capabilities, DiGi is well-placed to further maximise revenue and optimise its infrastructure use. Furthermore, this will provide greater opportunity for DiGi to address dedicated and segmented offerings to customers as well as design dedicated below-the-line (BTL) campaigns and engagements.
  • Statistics shows that DIGI subscribers are increasing over the years. Still got room of improvement.
Intangible Assets Moat: Wide

  • DiGi placed significant importance on sustainable operational efficiencies to support its growth and to deliver the best customer experience.
  • Cost of goods sold (COGS) and operational expenditure (Opex) were managed prudently, driven by strong cost management discipline throughout the organisation, with visible efficiencies obtained from the recently completed network modernisation exercise.
  • High ROIC and CROIC above 15% in the past 9 years – This is a proof of excellent operational efficiency in DIGI.
Efficient Scale Moat: None

The following chart shows ROIC and CROIC of DIGI in the past 10 years. By MorningStar’s definition of economic moats, DIGI enjoys very wide economic moats in Malaysia.

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Profitability

From FY10 to FY14, DIGI’s revenue has been growing 6.4% annually in average, and DIGI was able to maintain EBITDA margin more than 40%. Nevertheless, in FY13 and FY14, DIGI’s EBITDA margin declined slightly because

  1. Higher capex in modernized its network
    1. 6 Mar 2014 – DIGI is committed to invest up to RM900 million in capital expenditure (capex) spending to capitalise on its recently modernised network to generate more growth in data. Although this will involve more capex (FY14 capex/sales ratio will be higher than FY13’s 11%), this is the right approach, as it will enable the telco to better monetise data by serving areas that are currently underserved, as well as close the gap with its peers and increase scale. By year-end, DIGI expects its 3G coverage to reach 86% (from 80% currently versus peers’ more than 85%) and roll out 1,000 long-term evolution sites.
    2. 13 Jul 2015 – DIGI strategically invested another RM200 million in capex to boost its data network coverage and quality with extensive 4G-LTE coverage available in all its key market centres.
  2. Higher marketing costs
  3. Higher customer acquisition costs (via heavy handset’s subsidies)
  4. Based on Moody’s standard, DIGI’s EBITDA margin is rated as Aa.

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Leverage & Cash Flow

In the past few years, in order to modernizing its network and increasing its market share, DIGI has been taking some gearing.

  1. FY14’s Debt/EBITDA – 0.33x (Aaa)
  2. FY14’s RCF/Debt – 125% (Aaa)
  3. FY14’s FCFF/Debt – 182% (Aaa)

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Coverage

For Telco, there are two important ratios to assess coverage:

  1. (EBITDA-CAPEX)/ Int. Exp. – This ratio considers the ability of a telco to cover interest expenses after it has made the necessary re-investments into it core operations. The concept represents the need to maintain/sustain operating cash flow, while servicing ongoing interest payments. It is important in the telecommunications industry as substantial investments in evolving and existing technology are required.
  2. (FFO+Int. Exp.)/ Int. Exp. – This ratio provides a measure of a telco’s ability to fund interest expenses from operational cash flow prior to payment of dividends, working capital movements, and capital expenditure investment.

By Moody’s standard, DIGI’s coverage is rated as Aaa. This is extremely healthy.

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FY15 Q2 Results

2Q15 vs. 2Q14, QoQ

2Q15 revenue was lower by 3.8% due mainly to lower device & other revenue while its service revenue remains relatively stable at RM1.59b (+0.1%). EBITDA improved by 1.7% to RM788m with margin enhanced to 45.7% (vs. 43.3% in 1Q15).

1H15 vs. 1H14, YoY

EBITDA margin improved as a flow through from lower device sales. However, absolute EBITDA declined 0.9% year-on-year due to the compounding effects from GST implementation, margins pressure from intensified price competition in the market and weaker MYR currency development.

Profit after tax (PAT) ended lower at RM464 million this quarter on the back of progressively higher depreciation and amortisation charges as well as higher tax expenses.

DIGI’s service revenue grew +1.3%yoy to RM1,589m from RM1,568m in 2Q14, driven by higher internet revenue growth of +24%yoy to RM507m. Total customer base increased 124k to 11.8m while internet subscribers gained further traction to 6.8m forming 57.9% of total subscribers from 49.4% in 2Q14. DIGI’s 1H15 cumulative earnings amounted to RM943.6m – in-line with ours and consensus expectations. This accounts for 45.4% and 45.5% of ours and consensus full year earnings estimates respectively.

Postpaid segment

imageSource: 2Q15 Quarterly Report In 2Q15, postpaid service revenue grew 3.5% YoY and 3.2% QoQ as a flow through from encouraging smartphone bundles commitments secured in the preceding quarter. Its subscriber base grew by 75k year-over-year to 1,771k in 2Q15, while the proportion of active internet subscribers increased to 76.3% of total postpaid subscribers. Average Revenue per User (ARPU) remained stable at RM82.

Prepaid

imageSource: 2Q15 Quarterly Report Prepaid service revenue remained steady with marginal growth of 0.5% year-on-year although sequentially lowered by 1.1% as a result of the recent changes in the prepaid market. DIGI continued to strengthen its stronghold with additional 111,000 subscribers and sealed the quarter with a total of 10.0 million prepaid subscribers.Both prepaid service revenue growth and ARPU were adversely impacted from competition intensity especially in IDD services and aggressive prepaid sim pack offers in the market. This was further compounded by effects from post GST implementation confusion and challenges which slowed down operational momentum significantly in 2Q 2015.

Blended

imageSource: 2Q15 Quarterly Report DIGI effectively challenged industry dynamics and secured service revenue growth of 1.3% year-on-year and halted negative sequential growth seen in 1Q 2015.DIGI added 124,000 more subscribers into its network, most of which are active internet users.

Internet subscribers rose to more than 6.8 million, representing 57.9% of the total subscriber base whilst smartphone penetration also reached a new level at 57.1%, a marked improvement from 41.9%, a year ago.

Internet revenue remained a strong catalyst for service revenue growth with an encouraging growth of 24.0% year-on-year.

Sequential internet revenue growth of 5.2% seen in 1Q 2015 was reduced to 0.4% in 2Q 2015 due to interim weaker spending post GST among the prepaid subscribers although demand for mobile internet remained strong.

Blended ARPU stayed resilient although moderated slightly to RM45 over an increasing subscriber base.

Total Cost Trend

imageSource: 2Q15 Quarterly Report Cost of Goods Sold (COGS) trimmed 8.2% year-on-year and 12.7% quarter-on-quarter mainly as a flow through from lower device cost consequential from higher mix of affordable smartphone bundles sold.The depreciation of MYR currency resulted in relatively higher IDD traffic cost while price competition intensity weighed in at the expense of revenue and margin.

Nonetheless, opex to service revenue ratio remained fairly resilient at 29.1%, consistent level as the last two quarters amid competition intensity and rapid expansion of data network.

Peer Comparison

Compare to others, subscriber base of DIGI increased constantly in the past 5 years.

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For postpaid segment, in overall, ARPU of three Telcos are stagnant, and DIGI ranked the 3rd position. For prepaid segment, DIGI ARPU can be considered the highest one, but its ARPU has been declining from 41 to 38.

Prepaid service ARPU of DIGI were adversely impacted from competition intensity especially in IDD services and aggressive prepaid sim pack offers in the market. This was further compounded by effects from post GST implementation confusion and challenges which slowed down operational momentum significantly in 2Q 2015.

Surprisingly, MAXIS prepaid ARPU increased from 34 to 38.

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In terms of EBITDA Margin, compare to MAXIS and AXIATA, DIGI maintains the 2nd position. Nevertheless, three of them enjoy very good margin so far.

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In terms of CROIC and ROIC, DIGI is obviously the most efficient company in generating revenue and cash flow. Despite MAXIS having some unfair competitive advantages in network infrastructure, DIGI is still able to achieve outstanding operational excellence in building very wide economic moats.

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Growth Drivers

  • 13 Jul 2015 – DIGI strategically invested another RM200 million in capex to boost its data network coverage and quality with extensive 4G-LTE coverage available in all its key market centres.
  • 9 Apr 2015 – TM and DIGI will tap each other’s customer base through a collaboration involving TM’s Internet Protocol television (IPTV).
    • TM will provide entertainment, sports and video on demand on its HyppTV to DiGi customers through mobile app “HyppTV Everywhere”.
    • IPTV revenue from the consumer segment continued to increase with higher number of buys for premium channels and Video on Demand
    • TM’s planned collaboration with DiGi comes at a time when TM needs to increase Internet, multimedia, and data-based revenue. This is crucial to mitigate the decline in voice and non-telecommunication related services income.
  • 27 Apr 2015 – Data traffic volume has increased to 19,900 terabytes (TB) against the previous years’ 9,900TB. With long-term evolution (LTE) network coverage rapidly expanding to more than 33% of the population, there will be increased data growth opportunity especially when the LTE network is now made available to prepaid subscribers.

Issues/Risks/Challenges

  • Potential irrational competition, especially in the prepaid segment, from U Mobile, MVNOs and OTT players.
  • Potential margins pressure as a result of the higher customer acquisition costs (via heavy handset’s subsidies)
  • Higher marketing costs to retain market share which may further pressure profitability
  • Regulatory risks – regulation of tariffs
  • FOREX – The weakening of MYR has also resulted in higher IDD traffic cost
  • Unable to monetize data
    • weaker than expected net adds
  • worse than expected voice tariffs
  • Dumb pipes – Operators like DIGI and Maxis cannot offer their traditional services (such as downloads of wallpapers, ringtones, games, applications, etc.) as Apple controls the total iPhone user experience.
  • The sudden change in chief executive officer (CEO) may dampen market perception of DiGi.Com’s leadership stability
    • DiGi.Com announced the appointment of Murty as its new CEO with effect from April 1.
    • The change in CEO was unexpected and it is unusual for DiGi.Com to change CEO within a year (previous CEOs: Henrik Clausen was there for four years, Johan Dennelind [two years] and Morten Lundal [four years]).
    • Nevertheless, Murty has been COO at DiGi.Com for more than a year and has worked in the company for more than 12 years, which enables significant cultural and operational familiarity with the group.
    • In addition, DiGi.Com’s effective management team and organisational process will ensure operational and business continuity despite the unexpected change in leadership.

Valuation

Historical EY%

  • Trailing:
    • FY14 (EPS: 0.261) – 6.16 (Uncertainty Risk: MEDIUM)
    • R4Q (EPS: 0.256) – 6.04 (Uncertainty Risk: MEDIUM)
  • Forward:
    • FY15 (EPS: 0.262 ± 5%) – From 5.88 to 6.50 (Uncertainty Risk: MEDIUM)
    • FY16 (EPS: 0.275 ± 5%) – From 6.17 to 6.82 (Uncertainty Risk: LOW to MEDIUM)
  • EPS applied to reach the current stock price (5.37): 0.228

Industrial Avg. EY%

  • Trailing:
    • FY14 (EPS: 0.261) – 6.44 (Uncertainty Risk: MEDIUM)
    • R4Q (EPS: 0.256) – 6.32 (Uncertainty Risk: MEDIUM)
  • Forward:
    • FY15 (EPS: 0.262 ± 5%) – From 6.15 to 6.80 (Uncertainty Risk: LOW to MEDIUM)
    • FY16 (EPS: 0.275 ± 5%) – From 6.46 to 7.13 (Uncertainty Risk: LOW to MEDIUM)

5-Y DCF

  • Good Scenario (9.0% – 11.0%): From 6.27 to 6.74 (Uncertainty Risk: MEDIUM)
  • Base Scenario (7.0%): 5.82 (Uncertainty Risk: MEDIUM)
  • Bad Scenario (3.0% – 5.0%): From 5.02 to 5.41 (Uncertainty Risk: HIGH to VERY HIGH)
  • Ugly Scenario (-1.0% – 1.0%): From 4.31 to 4.65 (Uncertainty Risk: VERY HIGH)
  • At current price (5.37), based on RDCF, assumption of FCFF growth rate in the next 5 years is 5%.

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Based on the above football field chart, I think fair value of DIGI is from 6.2 to 6.8.

Returns to Shareholders

In the past 10 years, DIGI maintains more than 100% dividend payout. High dividend payout makes DIGI a defensive stock.

4 Mar 2015 – DIGI plan to set up a business trust to increase the telecommunications giant’s capital efficiency and return excess cash to shareholders remains “on track”. DiGi first announced its plan to set up a business trust in April 2013, but not much has been said about it since. DIGI is still engaging stakeholders and regulators on setting up the business trust. A business trust is a trust that runs and operates a business enterprise. Registered business trusts must have a trustee-manager, whose role is to safeguard the interests of beneficiaries or unit-holders of the trust and to manage the business of the trust. It is still a relatively new framework in Malaysia and Norling had previously said back in 2013 that because of the newness of the framework, DiGi needed time to fully understand the implications of setting up the trust, and the benefits as well as the limitations that would come with it.

Going Forward

All in all, Digi delivered a resilient performance in 1H 2015, with service revenue growth of 1.8% at 45% EBITDA margin on the back of competition intensity and GST implementation challenges. Digi believes growth momentum will improve in the second half of 2015 alongside with stronger consumer sentiments after a period of adjustment post GST and continuous strong demand for quality mobile internet services.

The 2015 guidance remained intact as follows:

  • Low to mid single digit service revenue growth
  • Sustain EBITDA margin and Capex similar to 2014 level

I will continue to hold and accumulate DIGI.

Resources

Excel – http://1drv.ms/1KiQaj9

Notes – http://tinyurl.com/q7hrudm

2Q15 Quarterly Report – http://www.bursamalaysia.com/market/listed-companies/company-announcements/4800865

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6 thoughts on “DIGI – Fundamental Analysis (21 Jul 2015)

      • Hi LC Chong,

        Thanks for your sharing, I would like to understand more on your valuation method.

        Can you also share how you estimated FCF GR (for DCF) for individual stock? Reference on EPS GR?

        Thanks,
        Sam

        Like

  1. Very good analysis here which is easy to understand.
    Digi does look attractive at this price but I’m concerned about the technical charts. Clearly on a downtrend here. That’s the main reason why I’ve held back from buying for now despite the very strong desire to have it.

    Clearly, Digi is for the genuine investor looking for yield. But if it’s possible to buy at a cheaper price, that’s what I’ll do. Will immediately come in when I’m reasonably satisfied it has found strong support.

    Liked by 1 person

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