PT XL Axiata: Industry Consolidation And Withdrawal Of Guidance In The Spotlight

Summary

• XL Axiata is possibly either acquiring or merging with a smaller Indonesian peer in the near future, but it is too early to judge the impact of any potential transaction.
• The company chose to withdraw its FY2020 guidance, and its FY2020 consensus estimates seem relatively high, which could potentially lead to earnings downgrades in the future.
• Axiata trades at 4.6 times consensus forward next 12 months' EV/EBITDA, and it offers a consensus forward FY2020 dividend yield of 1.3%.
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Elevator Pitch

I downgrade my rating on Indonesia-listed PT XL Axiata Tbk (OTCPK:PTXKY) (OTC:PTXAF) [EXCL:IJ] from Bullish to Neutral.

This is an update of my prior article on XL Axiata published on February 18, 2020. XL Axiata's share price has declined by -1.5% from IDR2,650 as of February 17, 2020, to IDR2,580 as of June 3, 2020, since my last update. XL Axiata trades at 4.6 times consensus forward next 12 months' EV/EBITDA, and it offers a consensus forward FY2020 dividend yield of 1.3%.

XL Axiata is possibly either acquiring or merging with a smaller Indonesian peer in the near future as part of the industry consolidation. But it is too early to judge the impact of any potential transaction without any indication of deal terms and transaction structure.

Also, XL Axiata chose to withdraw its FY2020 guidance, and the FY2020 consensus estimates seem relatively high, which could potentially lead to earnings downgrades in the future. As such, I downgrade my rating on XL Axiata to Neutral. But I think that a Bearish rating will be too harsh, considering the potential upside from industry consolidation in the medium to long term.

Readers have the option of trading in XL Axiata shares listed either on the Over-The-Counter Bulletin Board/OTCBB as ADRs with the tickers PTXKY and PTXAF, or on the Indonesia Stock Exchange with the ticker EXCL:IJ. For XL Axiata shares listed as ADRs on the OTCBB, note that liquidity is low, and bid/ask spreads are wide.

For shares listed in Indonesia, there are limited risks associated with buying or selling them in terms of trade execution, given that the Indonesia Stock Exchange is one of the major stock exchanges that is internationally recognized, and there is sufficient trading liquidity. Average daily trading value for the past three months exceeds $3 million, and market capitalization is above $1.9 billion, which is comparable to the majority of stocks traded on the US stock exchanges. Institutional investors who own XL Axiata shares listed in Indonesia include Brandes Investment Partners, Norges Bank Investment Management, The Vanguard Group and MFS Investment Management, among others. Investors can invest in key Asian stock markets either using U.S. brokers with international coverage, such as Interactive Brokers, Fidelity, or Charles Schwab, or local brokers operating in their respective domestic markets.

All Eyes On Potential Industry Consolidation

Reuters reported on May 23, 2020, that the CEO of XL Axiata's parent Axiata Group Berhad (OTCPK:AXXTF) [AXIATA:MK], Jamaludin Ibrahim, disclosed that the company has been in discussions with all the small Indonesian telecommunications companies with the exception of market leader Telekomunikasi Indonesia (TLK) (OTCPK:TLKMF) [TLKM:IJ] on potential acquisition or mergers via share swaps. In the article, Jamaludin Ibrahim noted that "COVID-19 makes it more a necessity to consolidate, even more than before", but he added that a deal will be done with only a single company.

In my initiation article on XL Axiata published on August 5, 2019, I had mentioned that the Indonesian authorities were in favor of consolidation in the telecommunications industry, and there were rumors of XL Axiata either acquiring or merging with Indonesian mobile operator PT Hutchison 3 Indonesia.

Following the Reuters article, research services provider D-insights noted in a May 27, 2020, article that "operators need to join forces to survive" given "inflated operational costs" as a result of the coronavirus pandemic. D-insights named PT Hutchison 3 Indonesia and PT Indosat Tbk (OTCPK:PTITF) [ISAT:IJ] as potential acquisition or merger candidates for XL Axiata. PT Hutchison 3 Indonesia has earlier indicated that it is "open to the possibility of acquisitions and mergers", while Indosat is not in good shape, having retrenched close to 700 employees in February 2020 to reduce costs.

A May 29, 2020, article published on Mobile World Live quoted a Fitch Solutions report which highlighted that the Indonesian telecommunications market "is heavily fragmented, with smaller operators incurring periods of losses as subscriber growth has failed to keep pace with investments."

It is noteworthy that XL Axiata also mentioned at the company's 1Q2020 earnings call on May 12, 2020, that "the (Indonesian telecommunications) market still has too many players" and the coronavirus pandemic could potentially "be a catalyst in terms of driving consolidation moving forward."

Ideally, industry consolidation should lead to lower competitive intensity with a fewer number of competitors, and reduced operating costs and capital expenditures as a result of greater economies of scale and network sharing. However, it is too early to judge at this point in time if any potential acquisition or merger will be value-accretive for XL Axiata's shareholders, since deal terms and transaction structure have yet to be confirmed. Also, a key hurdle to any potential industry consolidation is that the regulators might not allow the companies involved in the acquisition or merger to share the respective network spectrum they have.

Withdrawal Of Guidance Suggests Downside Risks To Consensus Estimates

Earlier in February 2020, XL Axiata guided for revenue growth "in-line with market" and a "low 40%" EBITDA margin for FY2020. However, XL Axiata chose to withdraw its FY2020 guidance, as the company announced its 1Q2020 financial results on May 11, 2020.

XL Axiata explained why the company withdraw its FY2020 guidance at its 1Q2020 earnings call on May 12, 2020. The company noted that "there will be likely a negative impact to the industry revenue, especially if unemployment of the population starts creeping up" and "the effects (of the coronavirus pandemic) are prolonged and last for the next six to nine months."

Market consensus expects XL Axiata to grow its revenue by +4.9% YoY from IDR25,150 billion in FY2019 to IDR26,379 billion in FY2020 and for the EBITDA margin to expand from 39.6% to 45.7% over the same period. There could be downside risks to XL Axiata's consensus numbers, implying potential earnings downgrades sometime down the road, if the coronavirus pandemic takes a longer time to be contained in Indonesia.

Notably, according to YouGov's survey of people in 22 countries published on June 1, 2020, Indonesia has the lowest percentage of respondents "who think the coronavirus situation is getting better in their country." Separately, XL Axiata observed at the company's 1Q2020 earnings call, there was " a shift of people buying smaller data packets or buying weekly or daily packets instead of monthly." This suggests that Indonesian consumers could be already tightening their purse strings in response to economic weakness as a result of the coronavirus pandemic.

Furthermore, competition remains intense in the Indonesian telecommunications market, and shows no signs of abating anytime soon. At the company's 1Q2020 earnings call, XL Axiata disclosed that "the prices in quarter 1 have been under big pressure" and "this has been like that already for a few months." The introduction of new cheap unlimited data plans and the lowering of prices for entry-level plans in 4Q2019 and 1Q2020 have added to competitive pressures in the industry.

Valuation

XL Axiata trades at 5.9 times trailing 12 months' EV/EBITDA and 4.6 times consensus forward next 12 months' EV/EBITDA based on its share price of IDR2,580 as of June 3, 2020. As a comparison, the stock's historical 5-year and 10-year mean consensus forward next 12 months' EV/EBITDA multiples were 5.4 times and 5.7 times, respectively.

The stock is also valued by the market at consensus forward next 12 months' EV/EBIT and P/E multiples of 18.7 times and 21.4 times, respectively.

XL Axiata offers consensus forward FY2020 and FY2021 dividend yields of 1.3% and 2.0%, respectively.

Peer Valuation Comparison For XL Axiata

Stock	Consensus Forward Next Twelve Months' EV/EBITDA	Consensus Forward Next Twelve Months' EV/EBIT	Consensus Forward Next Twelve Months' P/E	Consensus Forward FY2020 Dividend Yield
PT Telekomunikasi Indonesia Tbk	5.5	8.8	15.7	5.0%
PT Indosat Tbk	3.4	40.6	N.A. as the company is expected to be loss-making	N.A. as the company is not expected to pay a dividend for FY2020

Click to enlarge

Source: Author

Risk Factors

The key risk factors for XL Axiata include engaging in acquisitions and mergers on terms that are not value accretive for shareholders, and lower-than-expected revenue growth and weaker-than-expected profitability leading to analysts' earnings downgrades.

Note that readers who choose to trade in XL Axiata shares listed as ADRs on the OTCBB (rather than shares listed in Indonesia) could potentially suffer from lower liquidity and wider bid/ask spreads.

Analyst’s Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.