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Saudi telecoms | Short-term outlook remains tough; Avoid sector

Tough regulations cloud telecoms market. Over the past 2-3 quarters, the CITC took measures, which clouded the sector in 1Q18 and should continue to in 2018, including: i) banning automatic renewal for bundles, as of Jan 2018, limiting revenue from out-of-bundle, ii) implementing a 5% VAT, starting Jan 2018, that should result in lower usage, iii) cutting MTR rates by 45% in Dec 2017, pressuring interconnection revenue, and iv) lifting the ban on VoIP services, as of end of 3Q17, decreasing revenue from international voice. To soften these headwinds, MNOs, namely, Zain KSA and Mobily, increased data prices directly and indirectly by c50%, and bundled on and x-net minutes, to take advantage of the lower MTRs to achieve higher redemption rates and higher out-of-bundle revenue. We expect price hikes will partially alleviate the CITC’s decisions and VAT implementation, but still that total telecom sector revenue will decline 5.6% y-o-y in 2018, before growing 3.2% the next year.

STC best-positioned in telecom sector, but Neutral on valuation. STC remains the top player in the market, with the healthiest margins, due to cost optimisation efforts, and a notably more liquid balance sheet. Our EBITDA growth projections are insufficient for an Overweight call, with the stock trading on a 2018e EV/EBITDA of 7.7x after its recent rally, higher than the industry average of 6.1x, however, justified by its 2018e dividend yield of 4.6%. Our growth outlook is limited, as we expect regulatory changes to drag the sector’s revenue and raise competition in the market, harming STC.

Dilution from Zain KSA’s capital restructure overlooked. At current prices, Zain KSA’s capital restructure (SAR2.2bn capital reduction and SAR6bn rights issue) remains overlooked by the market, in our view. We believe this will dilute valuation by 25% at the current share price, leading to c31% downside, assuming the theoretical post-rights issue market price of SAR10.3/share. We reiterate our Underweight rating on the stock, with a TP of SAR6.27/share (SAR7.10/share post rights), noting that the rights issue proceeds should still leave leverage at relatively elevated levels: 4.5x net debt/EBITDA in 2019e vs. Mar-18 levels of 6.3x.  

Hard to justify Mobily’s elevated valuation. Although Mobily’s performance has been stable over the past 3 quarters on the EBITDA level, we maintain an Underweight call, as it has unjustifiably reached a 10-month high with a 2018e EV/EBITDA 7x, 15.2% higher than global peers average. We also see Mobily’s cash flow generation insufficient for capex expansion, due to debt obligations. Mobily’s net debt to EBITDA currently stands at 3.4x vs. the global peer average of 1.4x. This may hinder the company’s ability to invest in its network.