Deutsche Bank Markets Research Asia Periodical Date Pan-Asia 21 November 2017 Telecommunications Asia-Pac Telecom Tracker Peter Milliken, CFA Research Analyst Relative valuation shines... investors (+852 ) 2203 6190 shield their eyes [email protected] Many cheap telcos, and signs of discipline returning Srinivas Rao, CFA Price, marketing, spectrum and capital discipline were on show in the quarter, Research Analyst and Chinese telco revenues were strong, yet sector earnings were sluggish, as (+65 ) 6423 4114 some of these initiatives take time to fully flow through, and as a degree of [email protected] front-loading costs appeared to occur. Value is becoming clearer, with relative P/Es at six-year lows, and relative EV/EBITDA 1 s.d. cheap, but investors need Raymond Kosasih, CFA catalysts to pay attention. The risk-on mode, however, is showing signs of tiredness. High yield bond spreads have bottomed, suggest risk appetite has PT Deutsche Verdhana Sekuritas Indonesia slowed - and generally this would have led to the telcos holding up against the Research Analyst market, not the substantial underperformance seen. (+62) 21 2964 4525 [email protected] No catalysts? Then why did low-growth Japan have another good quarter? In the last three months, Japan telcos gained 7% while APAC x JP telcos fell 5%. That has really been the story since the GFC. Over the last five years, Gio Dela-Rosa, CFA Japanese telecoms have tripled, while APAC x JP telcos have been stationary. Deutsche Regis Partners, Inc. The success of the Japanese telecoms is based on several factors, that the Research Analyst APAC x JP telcos now feature (albeit to a smaller degree): 1) Minimal investor (+63) 2 894 6642 belief, 2) Low valuations, 3) Improving earnings discipline, 4) Increased [email protected] shareholder friendliness, and 5) Growth beyond traditional services. The question is does the APAC x JP telco disinterest continue downwards until James Wang telecoms trade at deep value, like the Japanese did, or will there be catalysts Research Analyst to excite the market in 2018? We believe investors are set to see better (+852 ) 2203 6145 returns, as we see emerging catalysts, such as: 1) Capex down-cycle driving a [email protected] FCF boom, 2) Pricing, marketing and spectrum discipline returning to varying degrees in PH, TH, TW, HK, SG and likely CH, 3) M&A driving synergies and consolidation, 4) IoT, cloud, content, etc as growth engines, 5) Chinese Craig Wong-Pan telecoms becoming more commercially driven, and 6) Potential inflows on any Research Analyst tech or inflation scare from tech equities and bonds respectively. The sector is (+61) 2 8258-2848 being priced as though the bull market will pass it by. If so, that will be the first [email protected] miss since the telecom index was born in 1994, and the first time a FCF up- cycle has not been rewarded by the market. As such we believe investors Top picks should lift exposure to value names. TLS, CT, SKT, KT, LGU, and ISAT, are all trading 1+ s.d. cheap vs. 10-year valuation ranges – which is remarkable given China Mobile (0941.HK),HKD78.15 Buy what the market has done in that period. Telstra Corporation (TLS.AX),AUD3.45 Buy SK Telecom (017670.KS),KRW254,500.00 Buy Valuation and risks We value the telecoms on DCF, and the holdcos on SOTP. Our WACCs are Idea Cellular Limited (IDEA.BO),INR95.00 Buy Source: Deutsche Bank typically based on local 10-year bonds, with risk premiums of 4.5-5.5%, and terminal growth rates of 0-2%. Key downside risks include: 1) Interest rates rebounding, cutting sector value, 2) Competition deteriorating, and 3) Risk of spectrum pricing rising on competitive or regulatory change. Key upside risks include: 1) Hype on IoT, e-commerce, and data monetization driving earnings estimates and multiples, and 2) Low, and even negative, interest rates leading to an upward squeeze in valuations. ________________________________________________________________________________________________________________ Deutsche Bank AG/Hong Kong This research has been prepared in association with PT Deutsche Verdhana Sekuritas Indonesia. The opinions contained in this report are those of PT Deutsche Verdhana Sekuritas Indonesia. Deutsche Bank does and seeks to do business with companies covered in its research reports. Thus, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision.Distributed DISCLOSURES on: 20/11/2017 AND 16:36:31 ANALYST GMT CERTIFICATIONS ARE LOCATED IN APPENDIX 1. MCI (P) 083/04/2017. THE CONTENT MAY NOT BE DISTRIBUTED IN THE PEOPLE’S REPUBLIC OF CHINA (“THE PRC”) (EXCEPT IN COMPLIANCE WITH THE APPLICABLE LAWS AND REGULATIONS OF PRC), EXCLUDING SPECIAL ADMINISTRATIVE REGIONS OF HONG KONG AND MACAU. 0bed7b6cf11c 21 November 2017 Telecommunications Asia-Pac Telecom Tracker Model portfolio Figure 1: DB’s APAC telecom portfolio 17-Nov-17 Return since Weighted Last rebal Sep 11 DB model Prior Price last rebal return Idea Cellular is our regional top pick, weight weight Local Last Q Local USD USD and we see a path to it doubling, so Australia TLS.AX AUD Telstra 20% 20% 3.47 3.72 -7% -12% -2.5% China 0941.HK HKD China Mobile 25% 25% 78.15 82.35 -5% -5% -1.3% we lift it to 20%. We have added China 0728.HK HKD China Telecom 10% 0% 3.85 4.02 -4% -4% 0.0% India IDEA.BO INR Idea 20% 15% 95.00 80.60 18% 16% 2.4% names with high upside to DB TPs, Indonesia ISAT.JK IDR Indosat 5% 0% 5,525 6,500 -15% -16% 0.0% Japan 9433.T JPY KDDI 5% 0% 2,977 2,936 1% -2% 0.0% but also add Hold rated KT Corp, due Korea 030200.KS KRW KT Corp 5% 0% 29,150 30,250 -4% -1% 0.0% Korea 017670.KS KRW SK Telecom 10% 10% 250,500 251,500 0% 3% 0.3% to a P/B and EV/EBITDA at levels in Cash 0% 0% line with typical sector troughs. We Deletions Hong Kong 1883.HK HKD CITIC Telecom 0% 10% 2.23 2.30 -3% -3% -0.3% cut SoftBank, as we are restricted. Japan 9984.T JPY Softbank 0% 10% 9,469 8,520 11% 7% 0.7% Hong Kong 6823.HK HKD HK Telecom 0% 10% 9.60 9.84 -2% -2% -0.2% Total 100% 100% DB model portfolio since rebal on 42985 -0.9% APAC telco index performance (MXAP0TC) 107.5 104.9 2.5% DB model portfolio since inception 24.4% APAC telco index (16 Oct 2015) 100.8 6.7% DB outperformance since inception (16 Oct 2015) 17.7% We select stocks based on: 1) Upside to target price, 2) Stock recommendation, 3) USD return potential, 4) Free float, 5) Relative value vs. regional telcos, 6) Short-term catalysts, 7) Sector thematics. We target holding period of 1 year - but can go higher to achieve our key goal of the best portfolio possible at each quarterly rebalance Red numbers are weight reductions Blue numbers are weight increases Source: Deutsche Bank, Bloomberg Finance LP; Past performance may not be a reliable guide to future performance This quarter has been the most difficult for arranging the model portfolio – as we can’t decide what to leave out. We are attracted to high earnings growth coming through in PH and TH to dividend yields 4%+ above 10-year bonds across DM leaders, to seemingly oversold operators in KR, AU and CH, actual and possible M&A stories, and to combinations of all of these. As such, the intriguing stories like DTAC, LGU, PLDT, Globe and China Telecom, failed to make our final list. The only ones eliminated were TPG, and Malaysian telcos, and we felt it easy to ignore NTT, StarHub, and Taiwanese operators. Everything else though had a case for inclusion. Korean operators are facing negative headwinds, but their share prices have suffered significantly, and we suspect IoT can be a strong theme for them in 2018 – that should offset some political fears. While Dan Kong has a Buy on SKT and Hold on KT, we cannot ignore 2.5x EBITDA and 0.65x. Other top picks are selected based on implied upside to our TPs, plus potential catalysts. Page 2 Deutsche Bank AG/Hong Kong 21 November 2017 Telecommunications Asia-Pac Telecom Tracker Key issues by market The year of discipline? Earnings have been held back by: 1) OTT cannibalizing voice and SMS, 2) Network roll-out lifting opex, and 3) Operators cutting price to drive migration to new networks. We believe the worst is over in all three cases, and sense management teams are under pressure to deliver. In 2017 we have seen marketing expense sharply reduced in the Philippines, Thailand and cut in Taiwan, and price rises in HK wireline, and some mobile price rises in IN, SG and TW. As such, we believe earnings growth is building, while capex is coming down. With FCF rising, rising payouts or investment in new growth areas, can drive a more exciting story for the sector. The exceptions seem to be Korea and Japan, but we believe the worst is over even in these markets. Figure 2: Key issues and top picks (of local analyst) Market Key issue Our take Market viewValuationTop pick 。TPG mobile build 。TPG unlikely to build a competitive network Challenged Good TLS Australia 。NBN impact 。TLS holding share, but margin steps down A UD0.22+ DPS chunky, with room for FCF 。Improving alignment 。Incentivization should mean less mobile discounting Improving Good CM China 。Declining capex 。Networks larely built out, capex should follow CU Rising sector FCF & shareholder friendliness.