Dialog Axiata PLC CASE FOR INVESTMENT. Earnings Review BUY Rs May 2016

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1 May14 Aug14 Nov14 Feb15 May15 Aug15 Nov15 Feb16 May16 May14 Aug14 Nov14 Feb15 May15 Aug15 Nov15 Feb16 May16 LKR Dialog Axiata PLC Earnings Review BUY Rs May 2016 CASE FOR INVESTMENT Being the market leader: Dialog Axiata is the market leader for Sri Lankan mobile market which accounted for nearly 43% of market share. Dialog broadband Network is Sri Lanka s second largest Fixed Telecommunications service provider, and also a leading provider of Radio and Optical Fiber based transmission infrastructure facilities. Attractive performance: The Company continues to perform well in both mobile and nonmobile (DTV and DBN) segments. Strong brand name and reputation: Strong brand name and reputation associated with the group also assists in the development of the business. Expanded business functions: DIAL is the pioneer for international roaming facility in Sri Lanka which comprises voice roaming collaborations through 617 operators in 225 countries around the globe. Improving demand: Increase in demand for smart phones will eventually improve the demand for mobile data which will positively contribute to the mobile operation segment. Strong infrastructure development: Dialog focus on expanding the high speed Fiber Optic network on island wide together with the establishment of strong International (SubMarine) Optical Fibre connectivity to the Global Internet via the Bay of Bengal Gateway (BBG) Cable project. Investor Guide FY2013 FY2014 FY2015 FY2016E FY2017E Revenue (LKR mn) 63,298 67,286 73,930 81,523 88,810 Growth 12% 6% 10% 10% 9% Gross Profit (LKR mn) 26,432 28,489 33,102 36,278 39,165 Growth 10% 8% 16% 10% 8% EBIT (LKR mn) 7,664 8,054 9,497 10,924 11,674 Growth 13% 5% 18% 15% 7% PAT (LKR mn) 5,201 6,098 5,187 6,673 7,622 Growth 14% 17% 15% 29% 14% Gross margin 42% 42% 45% 45% 44% Operating margin 12% 12% 13% 13% 13% Net margin 8% 9% 7% 8% 9% ROE 13% 14% 11% 13% 14% ROA 5% 5% 4% 6% 6% EPS (LKR) BVPS (LKR) MPS (LKR) PE (x) PBV (x) DPS (LKR) Dividend payout 45% 17% 50% 39% 34% Debt to equity 74% 67% 54% 57% 51% A Member of the Colombo Stock Exchange Key Data Foreign BrokerDealer of Maybank Kim Eng Securities USA Inc. Sector Telecommunication CSE ticker DIAL.N0000 Shares in issue 8.1bn Public holding 16.68% 52wk High Low LKR Avg. daily volume 1,838,038 Current MPS LKR Market Cap LKR 92.8bn Market Cap USD 0.6bn Major Shareholders 31 st March 2016 Axiata Investments (Labuan) Ltd 83.3% Employees Provident Fund 2.4% HSBC INTL Nom LimitedBBH 2.1% Genesis Smaller Companies HSBC INTL Nom LimitedSSBT National Westminster Bank PLC as depositary of 1.2% first state Indian subcontinent fund CITI Bank Newyork S/A 0.9% Norgens Bank Account 2 Top 20 shareholders 96.0% Foreign ownership* 93.9% *as at 18 th May ,000 7,000 6,000 5,000 4,000 3,000 2,000 1,000 PriceVolume Graph ASI VOLUME ASI vs. DIAL PRICE PRICE Millions LKR DIAL Page 1

2 Q4 14 LKR million Q4 14 1Q 16 LKR Billions Financial Performance 1QFY2016 Net earnings up remarkably by 35%YoY on improvement in revenue and decline in finance costs The group recorded a notable profit growth of 35%YoY to LKR 2.7bn in 1QFY2016 compared to LKR 2.0bn reported in 1QFY2015. It was up by 330%QoQ compared to LKR 621mn reported in December The profit growth was led by the significant increase in revenue, share of associates profit and lower forex losses. Topline grew 22%YoY and 6%QoQ to LKR 21bn in 1QFY2016; underpinned by strong growth momentum in Mobile, Digital Pay Television, Teleinfrastructure and Fixed Line businesses. The two associates of the group Digital Commerce Lanka (Pvt) Ltd (Wow.lk) and FirstsourceDialog Solutions (Pvt) Ltd posted positive earnings, with a growth of 103%YoY to LKR 0.3mn in the quarter against the loss of LKR 11mn reported in the comparative year Turnover vs. Profit Margins 50% 45% 40% 35% 30% 25% 15% 10% 5% 0% Finance cost reduced by 23% to LKR 324mn in 1QFY2016 compared to LKR 472mn reported in 1QFY2015 mainly because of the reduction in forex losses. The group has absorbed LKR 10bn rupee loan in March 2016 to mitigate the impact of forex exposure on foreign currency borrowings. Turnover Gross Margin Net Margin Strong revenue performance and the one off taxes incurred in the last quarter conveyed the EBITDA to a noteworthy growth of 25%QoQ and 17%YoY to LKR 7bn in 1QFY2016. EBITDA margin was moderately declined from 35% to 33%. A one off levy of Rs.250mn charged on every licensed mobile telephone operator has been charged as expenditure incurred during December 2015 quarter. Gross margin improved from 45% to 46% during the quarter compared to the comparative year. Both operating and net margins gained the stance as operating margin inclined from 11% to 13% and net margin inclined from 11% to 13% supported by strong top line. ROIC was at 17%. The group s total interest bearing borrowings increased by 14%YoY to LKR 32.7bn from LKR 28.8bn. Debt to equity ratio inclined from 62% to 66%. The company used to finance capital expenditure through USD borrowings in the past, backed by its parent Axiata Company. However, due to expectations of further depreciation of the LKR, DIAL is planning to retire some foreign debt and refinance them using domestic debt. Group capital expenditure for 1QFY2016 was recorded at LKR 2.9bn (+69%YoY, 72%QoQ) which was considerably lower compared to 4QFY2015 CAPEX of LKR 10.6bn. The CAPEX was mainly attributed towards high speed broadband infrastructure and extension of Optical Fibre Network (OFN) in order to further strengthen the group s ICT sector. 12,000 11,000 10,000 9,000 8,000 7,000 6,000 5,000 4,000 3,000 2,000 1,000 CAPEX investments 53% 32% 21% 14% 13% CAPEX CAPEX intensity 60% 55% 50% 45% 40% 35% 30% 25% 15% 10% The company has been able to manage their CAPEX between 30%40% levels in last five years, and maintain a healthy Capex to revenue ratio. DIAL Page 2

3 Q4 14 LKR Billions Q4 14 Millions Segmental performance Dialog Mobile Number of Mobile Subscribers Mobile operations segment reported a revenue growth of 6%QoQ and 22%YoY to LKR 18bn underpinned by healthy growth in subscriber base, strong growth in data, voice and value added services Mobile voice revenue grew by 3%QoQ and 12%YoY while Mobile data revenue improved significantly by 60%YoY and 9%QoQ backed by higher subscriber additions and increased usage. 6 4 Earnings grew at a pace of 56%YoY and 229%QoQ to LKR 3bn in 1QFY2016 compared to LKR 2bn reported in 1QFY2015 backed by strong growth in revenue, EBITDA and lower forex losses. 2 0 EBITDA improved by 31%QoQ and 24%YoY to LKR 6bn in the quarter compared to LKR 5bn reported in the comparative year. EBITDA margin was slightly improved from 34% to 35%. Prepaid Postpaid Small scale screen data users have been the key driving force behind this growth. Average revenue per user (ARPU) grew marginally by 4%QoQ and 12%YoY to LKR 393 in the quarter. This was fuelled by the strong contribution from data revenue; value added services and local voice revenue Blended ARPU & MOU However, minutes of use (MOU) have been lower; 140 minutes recorded in 1QFY2016 compared to 144 minutes reported in 1QFY2015. The decline was mainly led by the use of other applications like Viber, Skype and WhatsApp. These applications also hurt the IDD revenue which witnesses a decline of 10% annually During 1QFY2016, Prepaid mobile segment witnessed a subscriber growth of 8%YoY but declined by 3%QoQ due to change in basis for permanent disconnection. Postpaid mobile segment recorded a subscriber growth of 2%QoQ and 7%YoY. Total mobile subscriber base improved by 8%YoY but declined by 3%QoQ. Blended ARPUs (Rs.) Blended MOUs The company s subscriber base improved to10.6mn as at the end of March 2016 compared to 9.8mn subscribers in March Subsidiary revenue distribution Dialog Broadband 2.5 Dialog broadband revenue was up by 6%QoQ and 21%YoY to LKR 2.1bn in 1QFY2016 led by the notable improvements reported in LTE & leased line and fiber sharing revenues Fixed revenue inclined by 25%YoY and 7%QoQ underpinned by growth in fixed LTE subscriptions and enterprise revenue Broadband subscriber base improved with a growth of 40%QoQ to 133, DTV DBB DIAL Page 3

4 FY2012 FY2013 FY2014 FY2015 FY2016 LKR Q4 14 Thousands EBITDA declined by 8%QoQ to LKR 750mn in 1QFY2016 impacted by increase in operating costs. However EBITDA improved by 25%YoY backed by strong growth in revenue supported by large volume of data usage Number of TV subscribers EBITDA margin slightly improved from 35% to 36% in the quarter compared to 1QFY2015. Net loss widen significantly by 49%YoY to LKR 119mn in the quarter compared to LKR 80mn loss recorded in the comparative year underpinned by the increase in depreciation accruing from Fixed 4G LTE related investments Dialog Television Television revenue increased by 4%QoQ and 8%YoY to LKR 1.6bn supported by strong subscriber growth in 1QFY2016. Postpaid Prepaid DTV revenue improved with a significant growth of 138%YoY (+QoQ) in prepaid subscribers as a result of the new prepaid discounted connection fee and flexible packages. Post paid subscribers grew by 11%YoY and 2%QoQ. Total subscribers grew by 8%QoQ and 39%YoY to 701,000 in 1QFY2016 where over 51,000 net additions witnessed during the quarter. Revenue contribution FY2015 8% 8% DTV cost increase was mainly led by the aggressive customer acquisition alongside service and product expansion activities resulted in a medium term reduction in EBITDA on YoY basis. EBITDA of the segment improved by 35%QoQ but declined by 90%YoY to LKR 31mn in 1QFY2016 compared to LKR 314mn reported in the comparative year. EBITDA margin declined from 22% to 2% on YoY basis. 84% Segment earnings declined by 231%YoY, from a profit of LKR 139mn in 1QFY2015 to a loss of LKR 182mn in 1QFY2016 back of decline in EBITDA. The loss narrowed marginally by 1%QoQ from the loss of 184mn reported in the December quarter. Mobile operations Fixed telephony & broadband Television Future Outlook We expect DIAL to record a profit growth of 29%YoY to LKR 6.7mn in FY2016 compared to LKR 5.2mn reported in FY2015 backed by increase in revenue and decrease in tax rates. Revenue may increase by 10%YoY to LKR 81.5bn in FY2016 and LKR 88.8bn, +9%YoY in FY2017, supported by television and broadband segments. Television segment may continue the positive momentum with a growth of 23%YoY to LKR 7mn in FY2016 while the fixed telephony & broadband segments may report revenue of LKR 7bn with a growth of 15%YoY. Dialog mobile operations may witness a growth of 11%YoY to LKR 69bn in FY Earnings per share 35% 30% 25% 15% 10% 5% 0% 5% 10% 15% Aggressive promotions on Dialog broadband and the 4GLTE technology may enable the segment to post healthy revenue. New innovative products such as easy TV and per day TV packages will give added advantage over competitors. EPS Growth DIAL Page 4

5 FY2010 FY2011 FY2012 FY2013 FY2014 FY2015 LKR FY2012 FY2013 FY2014 FY2015 FY2016 The Telecommunications Regulatory Commission enforced a common minimum retail voice call rate for onnet and offnet domestic voice calls, to support competition between large and small network operators. This may positively impact to DIAL as other operators cannot not compete on the price. 75% Debt to Equity 74% However, dialog voice segment had witnessed a slowdown last few years. The company expects that the main segments will saturate after 45 years as most of the innovative products get generalized thereafter. 70% 65% 67% 67% In order to penetrate the market in the future, DIAL is investing and testing on new mobile products such as mobile advertising, mobile commerce, and mobile payments, further improved mobile TV etc. The company plans to further add features to the Easy cash mobile payment service to make the product more popular in the country. 60% 55% 50% 54% 57% The VAT and NBT exemptions for import or local purchase of any machinery or high tech equipment for telecom industry and supply of telecommunication services were totally removed from May Therefore the new VAT rate of 15% and the NBT of 2% will be charged from the telecommunication providers. However, with the inelastic market environment most of the telecommunication companies pass the VAT amount to the final consumer. Hence, the margins may not effect as much as from the VAT burden. Nonetheless, the NBT may affect the margins of the company. Gross margin may remain at 45% level in FY2016 while operating margin may remain unchanged at 13%. Gross profits may hurt by the expansion on direct costs following to the macro economic factors. Net margin may slightly increase from 7% to 8%. Return on equity may improve from 11% to 13% in FY2016 while return on assets may improve from 4% to 6%. Debt to equity ratio may incline to 57% in FY2016 compared to 54% in FY2015. Valuation 0.35 DPS & DPO 60% The counter is currently trading at a 4QT PE of 15.8x which is a 10% discount to the telecommunication sector PE of 17.4x while the PBV of 1.9x is trading at a premium to the sector PBV of 1.4x. DIAL is an attractive dividend payer who maintains a healthy dividend payout ratio. The company declared a dividend of LKR 0.32 per share for FY 2015 which translated to a dividend payout of 50% % 40% 30% 10% Based on a reasonable average historical PE, PBV calculation, the medium to long term target price for the share is LKR which is an upside of 7% to the current market price DPS Dividend payout 0% DIAL Page 5

6 52wk High Price 12.1 Historical PE Price 12.4 Historical PBV Price 11.9 Current MPS wk Low Price 9.70 Quarter Earnings Summary LKR Million 1QFY16 1QFY15 Change% Revenue 21,157 17,331 22% Direct costs (11,407) (9,593) 19% Gross profit 9,751 7,738 26% Distribution costs (3,104) (2,282) 36% Administrative costs (3,302) (2,773) 19% Other income % Operating profit 3,358 2,684 25% Finance income % Finance costs (362) (472) 23% Finance costs net (324) (359) 10% Share of loss from associates net of tax 0.3 (11.1) 103% Profit before income tax 3,035 2,314 31% Income tax expense (368) (332) 11% Net Profit for the period 2,666 1,982 35% Profit for the period of Equity Holders 2,670 1,982 35% Total Assets 123, ,837 10% Total Equity of Equity Holders 49,937 46,773 7% Total NonCurrent Liabilities 30,404 28,882 5% Total Current Liabilities 43,408 37,182 17% Total Interest bearing borrowings 32,745 28,815 14% EPS (LKR) NAV (LKR) Gross Margin 46% 45% Operating Margin 16% 15% Net Margin 13% 11% Debt to Equity 66% 62% Peer Comparison Annualized EPS MPS (LKR) NAV (LKR) PE (x) PBV (x) ROE% (LKR) CSE % Telecommunication Sector % DIAL % SLTL % DIAL Page 6

7 Disclaimer This information and opinion contained in this report have been complied by our research department from sources believed by it to be reliable and in good faith, but no representation or warranty, express or implied is made as to their accuracy, completeness or correctness. All opinions and estimates contained in the document constitute the department s judgment as of the date of this document and are subject to change without notice and are provided in good faith but without legal responsibility. This report is not, and should not be construed as, an offer to sell or a solicitation of an offer to buy any securities. Capital Trust Securities (Pvt) Ltd. (the company) or persons connected with it may from time to time have an investment banking or other relationship, including but not limited to, the participation or investment in commercial banking transactions (including loans) with some or all of the issuers mentioned therein, either for their own account or the account of their customers. Persons connected with the company may provide or have provided corporate finance and other services to the issuer of the securities mentioned herein, including the issuance of options on securities mentioned herein or any related investment and may make a purchase and/or sale, or offer to make a purchase and/or sale of the securities or any related investment from time to time in the open market or otherwise, in each case either as principal or agent. This report may contain forward looking statements which are often but not always identified by the use of words such as anticipate, believe, estimate, intend, plan, expect, forecast, predict and project and statements that an event or result may, will, can, should, could or might occur or be achieved and other similar expressions. Such forward looking statements are based on assumptions made and information currently available to us and are subject to certain risks and uncertainties that could cause the actual results to differ materially from those expressed in any forward looking statements. Readers are cautioned not to place undue relevance on these forward looking statements. Capital Trust Securities expressly disclaims any obligation to update or revise any such forward looking statements to reflect new information, events or circumstances after the date of this publication or to reflect the occurrence of unanticipated events. Exchange rate fluctuations may affect the return to investors. Neither the company nor any of its affiliates, nor any other person, accepts any liability whatsoever for any direct or consequential loss arising from any use of this report or the information contained therein. Capita TRUST Securities (Pvt) Ltd, their respective affiliate companies, associates, directors and/or employees may have investments in securities or derivatives of securities of companies mentioned in this report, and may make investment decisions that are inconsistent with the views expressed in this report., it s directors, officers, consultants, employees, associates or business partner, will not be responsible, for any claims damages, compensation, suits, damages, loss, costs, charges, expenses, outgoing or payments including attorney s fees which recipients of the reports suffers or incurs directly or indirectly arising out actions taken as a result of this report. DIAL Page 7

8 TELEPHONE : (011) HOTLINE : (011) FAX : (011) E MAIL : inquiries@capitaltrust.lk TRADING DIVISION BOARD OF DIRECTORS Tushan Wickramasinghe (011) Moksevi Prelis (Chairman) Dakshana Gooneratne (011) Tushan Wickramasinghe (Managing Director/CEO) Lawrence David (011) Methmal Senivirathne (CFO) M J M Husni (011) Sandesh Jayakody (011) Nilantha Perera (011) Saliya Gamagedera (011) Asanka Perera (011) Shanmugassharma Rakesh (011) Rasika Vidanalage (011) Thilina Yahampatharachchi (011) Sajee Perera (011) Gayan Vithanage (011) Anushan Kandasamy (011) Shehan Mendis (011) Chamila Fernando (011) Dilshard Hameed (011) Danushka Arambegedra (011) Laxman Ratnayake (011) KANDY BRANCH Arjuna Wilbawa (081) Dasantha Herath (081) Mohomed Faizan (081) FAX (081) KURUNEGALA BRANCH Dammika Senarathne (037) Indunil Pradeep (037) FAX (037) NEGOMBO BRANCH Sanjeewa Perera (031) Narada Abeysinghe (031) Srikanth Anton (031) FAX (031) MATARA BRANCH Venura Gamage (041) Jagath Rathnayake (041) Tharanga Wijeweera (041) FAX (041) MORATUWA BRANCH CAPITAL TRUST RESEARCH (PVT) LTD Suneth Fernando (011) Charitha Gunasekere (011) Bhanuka De Silva (011) Melani Nawaratne (011) Asoka Dharmatilaka (011) Ruvini Kaushalya (011) FAX (011) CUSTOMER SERVICE DIVISION CAPITAL TRUST CREDIT (PVT) LIMITED Prashani Perera (011) (011) ACCOUNTS DIVISION CAPITAL TRUST FINANCIAL (PVT) LIMITED Methmal Senivirathne (011) Anushan Kandasamy (011) Ranjini Jayawardena (011) Subani Wimalarathne (011) Kumari De Alwis (011) DOCUMENTATION DIVISION N.M.A Navaratne (011)