AXIATA–Fundamental Analysis (25 Aug 2015)

At the time of writing, I owned shares of AXIATA.
Changes:
  1. 24 Aug 2015 – First write up of AXIATA using new style, and covers FY15 Q2 results.

Important: MYR in ‘000s except per share data

Business Profile

The AXIATA Group is principally engaged in the provision of mobile services, leasing of passive infrastructure, and others such as provision of interconnect services, leased services, pay television transmission services and provision of other data services.

It provides its mobile communication services and network transmission related services predominantly in Malaysia under the brand name “Celcom”. The Group also has controlling interests in mobile operators in Indonesia (PT XL Axiata Tbk) under the brand name “XL”, Sri Lanka (Dialog Axiata PLC) under the brand name “Dialog”, Bangladesh (Robi Axiata Limited) under the brand name “Robi”, Cambodia (Smart  Axiata Company Limited) under the brand name “Smart” and significant strategic stakes in India under the brand name “Idea”, and Singapore under the brand name “M1”. The Group also has stakes in non-mobile telecommunications operations in Pakistan under the brand name “Multinet”.

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The Group has also established a communications infrastructure solutions and services company called “edotco”.  The Axiata Digital Services unit was set up also to focus on digital entertainment, digital commerce, digital payment and digital advertising services.

The following chart shows revenue by geographical locations in 2014.

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Ownership

Main shareholders of AXIATA are government linked and private institutional funds. Liquidity of this counter is very high.

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Economic Moats

Cost Advantage (Moat: Narrow)

  • Higher ARPU if compare to DIGI, but lowest net profit margin if compare to MAXIS and DIGI.

Switching Costs (Moat: None)

  • Nowadays, changing Telco is piece of cake. However, good coverage service will retain subscribers longer.

Network Effect (Moat: Narrow)

  • Statistics shows that AXIATA subscribers are increasing over the years.
  • Number of CELCOM subscribers is higher than MAXIS and DIGI.

Intangible Assets (Moat: Narrow)

  • Large network of dealers and shops

Efficient Scale (Moat: None)

 

The following chart shows ROIC and CROIC of DIGI in the past 5 years. If you compare this to DIGI, AXIATA doesn’t enjoy economic moats as wide as DIGI.

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Profitability

AXIATA managed to grow its revenue in 4.8% CAGR (FY10: 15,620,674; FY11: 18,711,777). However, in contrast, AXIATA’s EBITDA didn’t grow in alignment to the growing revenue. This also shown in its declining margin, from 45.5% (FY11) to 40.2% (FY14). Based on Moody’s standard, AXIATA’s EBITDA margin is rated as A.

The drop in margin is mainly caused by:

  1. Higher operating expenses in expanding business to other countries
  2. Higher marketing costs
  3. Aggressive competition in Indonesia has impacted profitability
  4. Cost incurred in merge and acquisition activities
  5. Higher customer acquisition costs (via heavy handset’s subsidies)

 

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Leverage & Cash Flow

In the past few years, AXIATA has been taking quite a high gearing for M&A activities and business expansion. For example,

  1. 2 Sep 2013 – AXIATA has an option to subscribe to its share, which may result in a cash outflow of about USD120m. AXIATA indicated that they are currently undertaking a business study of the above-mentioned cash call, which we believe the country’s policy execution risk will remain as one if its key consideration. As of end 2Q13, AXIATA has cash pile of RM6.6b with a gross debt to EBITDA ratio of 1.89x. The ratio is still below its optimal capital structure of 2.0—2.2x gross debt/EBITDA level, thus suggesting that AXIATA still has headroom to leverage up if need be.
  2. 24 Apr 2014 – PT XL Axiata Tbk (XL Axiata), a unit of Axiata Group Bhd, is seeking new funds to refinance its debt of 1.7tr rupiah (RM500m) in the second half of the year. Kontan, a local Indonesian finance and business newspaper, quoted XL Axiata finance director Mohamed Adlan, as saying after the company’s annual general meeting (AGM) two days ago that it had approached a few banks for new funds. However, he did not specify the banks. XL Axiata was reported to have amassed 24.97tr rupiah in debts as at the end of last year. Its debt-to-equity ratio grew to 1.63 times at the end of 2013 due to its acquisition of PT Axis Telekom Indonesia (PT Axis) for US$865m (RM2.83bn). XL Axiata was reported to have secured new funds early this year amounting to US$1bn, primarily to pay for the acquisition of PT Axis.

As of FY14, AXIATA’s leverage and cash flow are as below:

  1. Debt/EBITDA – 1.85x (A)
  2. RCF/Debt – 34.7% (Baa)
  3. FCFF/Debt – 16.5% (Aa)

To avoid from being overly leveraged, AXIATA has been setting capex guidance. FY15 capex guidance is MYR4.8b.

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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, AXIATA’s coverage is rated as A, which is still at healthy level.

 

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FY15 Q2 Results

6M15 revenue of RM9.45 billion (+2% y-o-y), was mainly driven by:

  1. Dialog (+16.3% YoY) on the back of contribution from higher mobile revenue (+5.7% YoY)
  2. Robi (+16.6% YoY) on growth in data revenue (+94.7% YoY)
  3. Associates contribution (+88.5% YoY) especially contribution from Smart by 55.4% YoY.

Axiata EBITDA weakened by 5bps to 37.2%, but rose on absolute by 1% YoY in 6M15 respectively. Axiata high cost trend still not over and hence, shaving EBITDA margin to 37.2% YoY (-5bps) in 6M15. Celcom and Dialog clocked-in noticeably higher operating cost as it rose by 4% YoY and 21% YoY respectively.

Despite resolving its IT issue, Celcom’s 2Q15 performance has been impacted by the GST implementation with flip flop decision in prepaid reload decision that has stopped its dealer and reseller in the selling of Celcom reload, pushing revenue to drop by 6.3% y-o-y to RM1.8 billion. Despite that, subscribers grew by 61k q-o-q with notable addition in postpaid segment. Prepaid segment saw Celcom lost 122k subscribers derailed by price cuts war by telcos.(M&A Securities, 21 Aug 2015)

XL’s net loss improved to IDR93 billion vs loss of IDR 758 billion in 1Q15 driven by lower forex losses. Revenue dropped by 7% y-o-y in 2Q15, however this was largely expected given the execution of XL’s new strategy to focus on higher value subscribers. EBITDA margins however improved to 35.5% (+16bps) on lower operating costs by 6.4% y-o-y on the back of lower network costs. The high value strategy has yet to translate into high subscribers numbers, which in turn declined by 6.1k subscribers. Management has guided 3 years transformation for XL separated under three waves, this includes revamping its product portfolio & pricing, stop high subscribers gross addition game, realigning traditional sales channels, and strengthening the management team. (M&A Securities, 21 Aug 2015)

Dialog’s revenue improved by +6.5% y-o-y (constant currency) in 2Q15 driven by higher mobile revenue due to higher broadband revenue. EBITDA margins for the quarter weakened to 33.4% from 34.5% in 1Q15 as a result of higher customer related costs and regulatory costs. Robi’s revenue grew 5.6% y-o-y (constant currency) driven by higher data revenue. EBITDA weakened on both absolute and percentage by 2% y-o-y and 7bps respectively.(M&A Securities, 21 Aug 2015)

Axiata’s capital spending accelerated by +28.7%yoy in 1H15 to RM2,284.0m in order to boost its mobile data leadership. Bulk of the capex was spent on its Indonesia (XL) and Bangladesh (Robi) operations amounting to RM894.0m and RM691.0m respectively.

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Source: Maybank, 21 Aug 2015

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Source: Maybank, 21 Aug 2015

Growth Drivers

  • 4 Dec 2014 – Axiata buys 80% in Singapore’s Adknowledge Asia Pacific for US$9mil
  • 9 Jan 2015 – Robi’s earnings growth potential
  • AXIATA’s strategic growth plans will focus on:
    • New services – investing aggressively in data services but moderately in digital services;
    • New approach – transforming its ?traditional core business to digitalising promotions, pricing and products;
    • New assets – pursuing in-country consolidation, small investment in digital services, while cautiously and opportunistically expanding new footprint in the region (prudent investment philosophy).
  • More cost savings from collaboration with DiGi.
  • 27 Apr 2014 – In Indonesia, AXIATA have launched digital commerce through an integrated commerce website called elevenia.co.id. It is an open market platform where you buy and sell online. It is a joint venture with a company called SK Planet, which is owned by SK Telecom, the No. 1 player in South Korea. AXIATA is also doing a similar thing in Sri Lanka on a smaller scale.
  • 2 Jul 2014 – Axiata announced that it has entered into an agreement with Samart Corporation Public Company Limited (Samart) to dispose its entire shareholding of approximately 24% of the total issued and outstanding share capital in Samart i-Mobile Public Company Ltd (Samart i-Mobile) for total gross consideration of approximately USD88.6m.
  • 1 Oct 2014 – PT XL Axiata is selling its 3,500 telecommunication towers there to PT Solusi Tunas Pratama for Rp5.6 trillion (US$460 million / RM1.5 billion). The deal would enable XL Axiata to unlock the value of its telecommunication towers at an attractive price. The sale proceeds will be used to reduce XL Axiata’s debt. XL Axiata would lease back the telecommunication towers from Solusi for 10 years with competitive terms, which would result in cost savings.

Issues/Risks/Challenges

  1. Irrational competition
  2. AXIATA is highly leveraged, and AXIATA has to restrict its capex to RM4.8b as guidance (FY15). A stronger MYR could result in weaker earnings due to translation risks
  3. Overpaying for M&A targets could result in impairment losses if the macro environment becomes unfavorable.
  4. SMS revenue continues to be under pressure in Malaysia & Indonesia due to intense competition from internet players (OTT)
  5. 7 May 2015 – Weaker revenue with lower subscriber base. In line with XL’s new business model which shifted subscriber acquisition strategy from volume to value, its prepaid subscriber base fell to 52m (4Q14: 59m, 1Q14: 68m).

Shareholder Return

The table below is a simulation of shareholder return. Assumptions:

  1. Commission paid is ignored in this simulation.
  2. The current price is as of the time of writing.
  3. Unit purchased is 1,000.
  4. Stock price as of 25 Aug 2015 was 5.87.
Time Frame Date Bought at Original Value Dividend Received Unrealized  Gain/Loss Current Return CAGR %
3-Y 24/08/2012 6.00 6,000.00 790.00 -200.00 6,590.00 3.2%
5-Y 20/08/2010 4.42 4,420.00 1,080.00 1,380.00 6,880.00 9.2%
7-Y 25/08/2008 4.152 4,152.00 1,080.00 1,648.00 6,880.00 7.5%

Valuation

Historical EY% Valuation

  • Trailing:
    • FY14 (EPS: 0.288) – 6.62 (Uncertainty Risk: MEDIUM)
    • R4Q (EPS: 0.33) – 7.58 (Uncertainty Risk: LOW)
  • Forward:
    • FY15 (EPS: 0.285 ± 5%) – From 6.22 to 6.88 (Uncertainty Risk: MEDIUM)
    • FY16 (EPS: 0.308 ± 5%) – From 6.72 to 7.43 (Uncertainty Risk: LOW to MEDIUM)
  • EPS applied to reach the current stock price (5.81): 0.255

Industrial Avg. EY% Valuation

  • Trailing:
    • FY14 (EPS: 0.288) – 7.11 (Uncertainty Risk: MEDIUM)
    • R4Q (EPS: 0.33) – 8.14 (Uncertainty Risk: LOW)
  • Forward:
    • FY15 (EPS: 0.285 ± 5%) – From 6.68 to 7.38 (Uncertainty Risk: LOW to MEDIUM)
    • FY16 (EPS: 0.308 ± 5%) – From 7.22 to 7.98 (Uncertainty Risk: LOW to MEDIUM)

5Y DCF

  • Good Scenario (8.0% – 10.0%): From 6.68 to 7.13 (Uncertainty Risk: MEDIUM)
  • Bad Scenario (5.0% – 7.0%): From 6.06 to 6.47 (Uncertainty Risk: MEDIUM to HIGH)
  • Bad Scenario (2.0% – 4.0%): From 5.50 to 5.87 (Uncertainty Risk: HIGH to VERY HIGH)
  • Ugly Scenario (-2.0% – 0.0%): From 4.83 to 5.16 (Uncertainty Risk: VERY HIGH)
  • At current price (5.87), based on RDCF, assumption of FCFF growth rate in the next 5 years is 4%.

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In my opinion, fair value of AXIATA range from 6.8 to 7.3.

Peer Comparison

Compare to others, subscriber base of CELCOM increased constantly from FY10 to FY13. A slight drop in FY14 was mainly caused by price war from competitors in acquiring new customer base. CELCOM has the highest number of subscribers in Malaysia.

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For postpaid segment, in overall, ARPU of three Telcos are stagnant, and CELCOM ranked No. 2. For prepaid segment, CELCOM ARPU can be considered the lowest one.

Prepaid service ARPU of CELCOM 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 DIGI, CELCOM’s margin is the lowest one. Nevertheless, three of them enjoy very good margin so far.

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In terms of CROIC and ROIC, AXIATA is obviously the least 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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Going Forward

Future prospects of strong earnings growth from the group’s main operating segments i.e. Celcom and XL remains as the primary concern mainly due to intensifying competition. Despite the IT and system problems limiting the group’s ability to launch new and more competitive products has largely been resolved, the group will still lag in terms of competitiveness. This is because its other peers have been rolling out very competitive products for the past many quarters, intensifying the price war.

XL’s transformation plan could be impacted as it battles Telkomsel and Indosat which are state-owned enterprises. At present, both segments contributed more than 70% to the group’s revenue. In addition, a sizeable exposure to forex would also apply downward pressure on the group’s profitability.

I will continue to hold AXIATA, and accumulate AXIATA when the timing is right.

Resources

Excel – http://1drv.ms/1NR5rIR

2Q15 Quarterly Report – http://www.bursamalaysia.com/market/listed-companies/company-announcements/4834121

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