Better than expected results boost interest in DiGi

DiGi.Com’s (RM25.50) recent earnings results for the third quarter (3Q) ended September 2010 were ahead of our expectations. In fact, the cellular operator has done very well in the year-to-date, relatively speaking, in an industry that is widely viewed as matured. Revenue in the first nine months was up 8.6% year-on-year (y-o-y) — despite the 40% downward revision in mobile termination rates (MTR) — while net profit grew a stronger 12.2% over the same period.

The company also surprised by announcing a higher-than-expected dividend payment of 50 sen per share, or roughly 134% of earnings for the quarter. In the previous two quarters, it had paid about 98% of net profits. DiGi indicated that the higher payout was attributed to its improved earnings and outlook going forward.

Certainly, its balance sheet has strengthened on the back of strong cash flow from operations. Gearing (measured as net debt to total capital) stood at just 9% at end-June 2010. Even after taking into account this latest round of dividends, its gearing will rise to about 27% — still well below DiGi’s optimal capital structure consisting of 35% to 40% borrowings.

Lower capex frees up cash for dividends

The government’s recent move to award the 2.6MHz spectrum through apparatus assignment (annual rental payments) rather than a potentially pricey auction may have also played a role in DiGi’s decision to up its dividends.

The 2.6MHz spectrum block will be utilised for the next generation of services (4G) coined Long Term Evolution or simply, LTE. Unlike the existing 2G and 3G networks that are essentially voice-centric with data capability added on for the latter, LTE is based on the Internet Protocol and designed primarily for high-speed broadband data services. DiGi targets to submit to the government its business plan for 4G services before the end of the year.

It is also hoping to secure additional spectrum in the 700MHz-900MHz bands under the government’s re-farming plans to boost its capacity and coverage. Few concrete details are known at this point but if allocations for the 3G, WiMAX and LTE spectrums are any guide, the upfront cost requirements will be minimal.

The company is also upbeat on its ongoing infrastructure sharing talks with Celcom. Progress is good and an agreement could be finalised within the next few months. If all goes to plan, the effort would pare overall capital expenditure requirements for both companies, in addition to operational costs savings.

Indeed, DiGi has guided its capex for 2011 at roughly the same levels as that spent last year and expects to spend about RM700 million this year. Lower capex — for spectrum and rollout — will free up more cash that can be distributed back to shareholders.

More than 100% profit payout sustainable
Based on our earnings forecast, DiGi could sustain a higher than 100% profits payout and still remain comfortably below its debt-to-equity ceiling. We estimate dividends will total 160 sen per share this year, assuming a final dividend of 40 sen per share. Recall that DiGi had earlier paid two rounds of 35 sen per share dividends in 1Q-2Q10. The ex-date for the third interim dividend of 50 sen per share was fixed for Nov 11.

This implies 110% payout of our estimated earnings of RM1.13 billion for 2010 — and will give shareholders a net yield of 6.3% at the current share price. Assuming a similar payout ratio, dividends would rise to roughly 173 sen per share in 2011, earning investors an attractive 6.8% net yield.

Broadband is the way forward
DiGi is convinced that broadband will remain the primary growth driver in the foreseeable future — as it continues to expand its 3G coverage, targeted to hit 50% by end-2010.

Case in point, data revenue grew 10% quarter-on-quarter (q-o-q) — in 3Q10, and accounted for 22.3% of the company’s total revenue during the quarter. Within this segment, the fastest growing is mobile Internet, which made up some 30% of data revenue, up from just 12% at the start of 2009.

By comparison, pre- and post-paid voice revenue, collectively, dipped 2% q-o-q, affected by the lower MTR. Adjusted for this, voice revenue would have been flattish.

Broadband subscribers increased by 48,000 to 170,000 while the number of post-paid subscribers was boosted by uptake for the company’s smartphone packages, including the popular Apple iPhone. In all, DiGi’s total subscribers grew 143,000 to 8.25 million by end-September 2010.

We expect to see more and more customers switching from pre-paid to post-paid-cum-data packages on the back of increasing adoption of smartphones in the country. Industry estimates at least half of the new handsets sold today are smartphones. The sale of the iPhone 4 is expected to further boost uptake in 4Q10. Reception for the latest Apple product has exceeded expectations. This bodes well for higher average revenue per user going forward — as consumers pay more for higher data consumption.

Competition will intensify with YTL Comms
Having said that, competition is expected to intensify further with the entry of YTL Comms into the mobile telecom space. The latter is targeting a nationwide launch for its WiMAX broadband services on Nov 18.

Whilst little detail is known of its product packaging and pricing, YTL intends to grab a share of both the mobile broadband and mobile Internet markets, both segments of which are currently dominated by the three largest cellular operators, Maxis, Celcom and DiGi. Only time will tell of its impact on the industry. — InsiderAsia


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, November 3, 2010.