Regional Asian telecommunication The Right Blend of Efficiency & Growth - DBS

This report analyses how:
• Capital efficiency, (never an easy thing to achieve), becomes ever more critical as EBITDA growth slows.
• Efficient telcos often (i) trade at lower PERs than their less efficient peers at similar EV/EBITDAs and, at the same time (ii) grow their earnings faster than EBITDA.
• XL and Axiata are our top picks. Indosat should be attractive in the longer term. China Unicom & True Corp may face hurdles.

The capex-efficiency tradeoff. Return on invested capital (‘ROIC’*) is a key measure of capital efficiency. An ROIC below 10% indicates lower returns than the cost of capital (assuming c.10%) and is too low for a company with mid-cycle growth prospects. Although excessive capex is often the root cause of low ROIC, cutting capex can also hamper growth, and it is this, which discourages companies from cutting capex. High capex, on the other hand, can lead to high depreciation and interest expenses, squeezing earnings significantly below EBITDA. This in turn manifests itself in higher PERs than more efficient peers at similar EV/EBITDAs.

Telcos offering growth and efficiency. XL & Axiata demonstrate an optimal balance between growth and ROIC. Earnings growth and thus PERs are attractive thanks to a slow rise in depreciation and a drop in interest costs. Indosat could be more interesting in 2012F as it focuses on improving ROIC by cutting capex..

Telcos facing challenges. China Unicom & True Corp have the lowest ROIC and highest PER within our coverage. Their ROICs are too low in view of their mid-cycle growth prospects.