Telekom Malaysia's share price has come under pressure after the government said the price of broadband would be reduced by 25% by year end.
KUALA LUMPUR: Fitch Ratings has revised Telekom Malaysia Bhd
's (TM) outlook to negative from stable due to its weakening credit profile, driven by pressure on earnings before interest, tax, depreciation and amortisation (EBITDA).
The ratings agencys said on Monday its long-term foreign-currency issuer default rating (IDR) and its senior unsecured rating are affirmed at 'A-'.
Fitch also also TM was impacted by its continuing high capex and dividend commitments.
“The company's goals for 2018 include flat earnings before interest and tax (EBIT) and revenue growth of 3.5%-4.0%, suggesting near-term cost pressure.
“Consequently, funds from operations (FFO) adjusted net leverage is likely to increase to 2.6x-2.7x in 2018-2019 (2017: 2.5 times), which may lead to a downgrade should there be a delay in deleveraging.
“We expect TM's continued dominance of the domestic fixed-line market and the ongoing modest expansion in 4G networks to support a leverage profile that is consistent with the rating,” it said.
Last week TM's share price came under selling pressure following the government's announcement to reduce the price for broadband by 25% by year-end.
Key rating drivers
Government Support Assessment: Fitch assesses TM using a top-down approach, equalising the company's IDR with the Malaysia sovereign (A-/Stable), in line with the new Government-Related Entities (GRE) Rating Criteria.
It views TM's status, ownership and control links with the state as 'Moderate', with its management team having greater oversight, despite the state's majority ownership of the company.
However, the government's record of support and expectation of support are assessed at 'Strong', given TM's financial standing and the high probability of support from the state.
“We also deem the financial implications of a default by TM to be 'Strong', and the socio-political implications of default at 'Moderate', reflecting the lower political and economic importance of the telecoms sector compared with the energy and utility sectors. Under our GRE criteria, TM's links with the sovereign score 22.5 out of a maximum of 60,” it said.
Leverage to remain high: Fitch expects free cash flow (FCF) to remain negative over the next three years, limiting TM's organic deleveraging capacity.
FFO adjusted net leverage has ranged between 2.2x and 2.5x since 2015, and is likely to remain high through the next two years.
Its forecast cash flow from operations of about RM3.2bil for 2018 will not be sufficient to meet dividend commitments and large capex.
TM maintains a policy to distribute yearly dividends of RM700mil or up to 90% of its normalised net profit after minority interest, whichever is higher (2017: RM812mil).
High capex: Capex/revenue is likely to stay elevated in the mid-20s in 2018 (2017: 25%), driven by TM's continued investments in its long-term evolution (LTE) network, a new data centre, and the suburban broadband (SUBB) project that is due to be completed in 2019.
However, Fitch expects capex to decline over time as TM plans to increase the efficiency of its assets to offer fixed-mobile convergence.
Fitch's capex forecast excludes any potential spectrum investments, so any significant debt-funded capex would further delay deleveraging.
Slow EBITDA growth: Fitch expects a relatively flat operating EBITDA of around RM3.6bil in the next two years (2017: RM3.5bil).
Mobile investments and the incremental cost needed to support TM's broadband improvement plan are likely to offset cost reduction efforts, including a programme to maximise the performance of its workforce.
Fewer government contracts and the government's aspiration to drive affordability of broadband services at higher speed could narrow margins further.
The government's recent announcement to lower broadband prices by 25% this year may hamper TM's plans to increase revenue and EBIT by 3.5%-4.0% in the medium term, though its convergence capabilities could ease the impact on cash flow.
Solid market position: The ratings reflect TM's strong market position in fixed-line services, which contribute a majority of its cash flows.
The company's convergence proposition through fixed voice, fixed broadband, internet protocol TV (IPTV) and mobile should enable it to compete more effectively against other fixed-line providers and mobile operators.
TM's nationwide fibre network and first-mover advantage are entry barriers for potential market entrants.
DERIVATION SUMMARY
Under Fitch's GRE criteria, entities such as TM with a standalone credit profile (SCP) within three notches of
the sovereign and a GRE score in the range 20-25, will generally be rated on a top-down basis, one notch below the sovereign.
However, where the GRE SCP-sovereign rating differential is a single notch, the GRE's rating can be equalised with the sovereign's, as has been the case for TM.
Its view that the Outlook on TM's 'BBB+' SCP is now Negative, leads to the Negative Outlook on the 'A-' supported rating.
If the SCP were to be downgraded to 'BBB'/Stable, our rating for TM would then be notched down once from the Malaysian sovereign rating, leading to a downgrade of the supported rating, given that the GRE SCP-sovereign rating differential would then be two.
TM's 'BBB+' SCP reflects its market dominance and the benign competition in Malaysia's fixed broadband market against its closest peer, Philippines' largest integrated telco PLDT Inc. (BBB+/Stable).
PLDT faces increasing threat of the entry of third mobile operator in the Philippines' duopoly telecoms market, amid the government's call to raise competition and increase the broadband speed.
However, TM's strengths are offset by its thinner operating EBITDA margins, which are likely to narrow further due to cost pressure from its mobile business and cuts in broadband tariffs.
TM's standalone rating sits comfortably among global fixed-line operators rated in 'BBB' rating category by Fitch. The company enjoys a dominant domestic position in the fixed-line segment and a supportive market structure, and lower leverage.
However, TM lacks the geographical breadth of some of the larger global incumbent peers, such as Deutsche Telekom AG (BBB+/Stable), BT Group plc (BBB/Stable) and Telefonica SA (BBB/Stable).
Adequate liquidity: TM had a cash balance of RM1.5bil at end-March 2018, which was sufficient to cover its short-term debt maturities of around RM1.1bil, including RM924mil of sukuk ijarah due in December 2018.
Its liquidity is strengthened by proven access to capital markets, which are supported by the company's market and financial position.
Total on-balance-sheet debt was RM8bil, of which 99% was unsecured debt and 29% was foreign-denominated debt, of which 49% is hedged.
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