Many good things coming together - Overweight
A year-ago we were pessimistic, now looking into 2016, we are strongly optimistic. This report highlights expected key themes.
They are positive:
1) The sector life cycle indicates data monetization will be widely achieved,
2) Digital content is gaining some traction in the region,
3) Top-line surprises as GDP accelerates globally and commodity prices plunge, lifting spending power,
4) Market repair continuing in under-earning operators,
5) Price setting and new-entrant concerns cycling down.
Double digit UP in 2015 has left many telcos at highly attractive prices - in an economic period majors tend to excel in. OW.
The key theme we see is risk-on – telcos love rate rise cycles
There’s 50% 47% and 43% for the telco index to reach its prior three sector peaks. The key themes above will we believe start to drive the sector back to such levels, as data-led growth and excitement over evolution into digital content builds. US rate rise cycles are special for telcos, with China Mobile, Bharti, SKT, PLDT and Telkom having their best years in such times. From Figure 9 the strong lesson is to increase exposure to high growth operators at this stage. Bravery should be rewarded.
Value is back - where to position
With the median telco in our Asian universe having underperformed 14% YTD, following a 9% drop (and 16% in USD), valuations have been restored in our view to very attractive levels. Since our September 2014 Rate Risk FITT we have been cautioning against TH, MY, PH, AU, SG and HK from a top-down point of view. With these markets having generally led the sector down, we now see fairly broad opportunities. Our top picks are Bharti, China Telecom, CITIC Telecom, LG-Uplus, PLDT and DTAC. We also like XL Indosat and SingTel. While we recommend to overweight the sector at this point, we are less enthusiastic about TW, JP, and MY, where multiples are elevated vs. their historic valuation multiple ranges, and as less growth is expected than at peers.
Valuation and risk
We value the sector using DCF using risk free rates in line with the local 10- year bond, risk premiums of around 5%, betas typically of 0.8-1.0x, and terminal growth of -0.5%-2%.
Key downside risks include:
1) A Chinese hardlanding slowing regional growth and so telco spend,
2) New licenses creating competition,
3) Government price controls. Key upside risks are largely mentioned above. (Read Report)