Shares in DiGi.Com have held up well over the past two weeks, since the reporting of its earnings for the first quarter of 2011 — despite the management’s guidance for lower profits for the rest of the year.

The company’s share prices had hit an all-time high of RM30.66 in early April before paring down gains. The stock is currently trading at RM29.30, up by almost 21% for the year-to-date, after taking into account dividends of 43 sen per share that were paid in February.

1Q11 earnings in line with expectations
The telco unveiled a pretty good set of earnings results for 1Q11, which were broadly in line with expectations. Turnover and net profit were up 10.9% year-on-year (y-o-y) and 19.1% y—o-y at RM1.43 billion and RM331.4 million, respectively. However, they were flattish from the immediate preceding quarter due, in part, to slower net subscriber addition of just about 78,000 in 1Q11. New broadband subscribers accounted for roughly 41% of the net adds.

By comparison, DiGi recorded an increase of 518,000 subscribers in 4Q10. In particular, the company eased off on its acquisition drive in the pre-paid segment in order to reevaluate its packages amid stiff pricing pressure from competitors. Total subscribers rose to 8.84 million as of end-March.

Positively, strong growth in data revenue helped offset the slight decline in voice revenue for both the pre-paid and post-paid segments. Data revenue accounted for 25.3% of total revenue in 1Q11, up from 20.3% and 23.4% in 1Q10 and 4Q10, respectively.

Growth in this segment was driven, primarily, by mobile Internet usage. Take-up rates for smartphone packages remain robust with our increasing need for always on connectivity to the Internet. DiGi estimates smartphone users make up roughly 15% of the company’s total subscriber base. We expect this figure can only continue to rise as subscribers upgrade from their existing, basic handsets.

Accelerated depreciation to dampen earnings in 2011-2012
More significantly, the management has guided earnings lower for the rest of the year, as the result of the decision to accelerate depreciation for its current mobile network assets.

DiGi recently inked a deal with Chinese telecommunications equipment vendor ZTE Corp to build a unified mobile network that will replace its existing platform. The new radio access network will be able to deliver 2G, 3G as well as future 4G services from a single base station site. The spectrum to deploy 4G services — also known as Long Term Evolution (LTE) — were allocated to various service providers last year and will be available for use by 2013.

The comprehensive network modernisation exercise is expected to replace over 5,000 existing base station sites, and will also include the addition of new sites for greater capacity and coverage, over the next two years. As such, the company will accelerate depreciation for the decommissioned assets, estimated to total some RM1 billion for RM1.1 billion over this period. The bulk of the increased depreciation charges are to be expensed in 2011-2012.

The additional depreciation charges will hit hard at the company’s bottomline. We estimate net profit will drop to roughly RM954 million and RM1 billion for 2011-2012, respectively — down from net profit of RM1.178 billion last year — despite our estimated 7% growth in turnover. We had previously estimated DiGi’s net profit for the current year at some RM1.34

DiGi recently inked a deal with Chinese telecommunications equipment vendor ZTE Corp to build a unified mobile network that will replace its existing platform.

billion.

But no impact on cashflow and dividends
Having said that, the higher depreciation expenses will have no impact on the company’s cashflow. Indeed, DiGi’s balance sheet is expected to strengthen further on the back of steady cashflow from operations and lower capital expenditure. The latter is estimated to be some 10% lower from last year’s spending, at roughly RM650 million. Net debt stood at just RM82.6 million at end-March, or equivalent to gearing of a little over 6%.

DiGi indicated that it would maintain the nominal amount of dividends paid, at least — despite the lower projected net profit. This would imply that dividend payout would well exceed 100% of net profit for the next two years.

Assuming annual dividends totalling 163 sen per share, the same as that paid in 2010, the company’s gearing level is expected to drop slightly from the current levels by end-2011 — and will turn into a net cash position by 2012. This would be far below the company’s target of an optimal capital structure, which would see gearing of between 54-81%. In this respect, DiGi could potentially raise its payout levels much further.

On the base-case scenario of dividends totalling 163 sen per share, shareholders will still earn a pretty decent net yield of 5.6% at the prevailing share price. Its shares will trade ex-entitlement for the first interim dividend of 43 sen per share on May 19.

Savings from improved network going forward
Looking ahead, DiGi is confident that margins will improve upon completion of the network modernisation exercise, by 2013. On top of the enhanced capacity and speed, the new network is expected to be much more efficient — including lower repairs and maintenance expenses — and energy saving.

The improved efficiency would be reinforced by the company’s ongoing network collaboration exercise with Celcom. Cost savings from the sharing of telecommunication sites, access, aggregation and trunk fibre transmission — in terms of both capital and operational expenditure — are expected to be visible starting 2012 and increase to some RM75 million to RM125 million annually post-2015.

DiGi has started work on decommissioning some 200 sites in Perak. To recap, the two telcos target to consolidate and upgrade some 4,000 sites — from the initial phase of a combined 436 sites — and fibre transmission network by 2015.

Thus, whilst pricing pressure will intensify, we expect DiGi will be able to hold its own by laying the foundation for greater competitiveness and higher quality of services going forward.


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, May 13, 2011.