XL Axiata EXCL IJ - Buy - Escaping the decade of doldrums

Escaping the decade of doldrums

In this note, we reiterate our Buy call on the stock. Of late, the stock has declined from a recent high of ~IDR2,600 to a current price of IDR2,160. While at the moment it is not clear when the planned merger with SmartFren (FREN IJ, Not rated) would be completed, we see improving profitability and cash flow trends for the company. For these reasons, we think the stock deserves a second look.

From 2010 up until 2019, EXCL ramped up its 3G BTS deployment. The company had healthy cash flows and 3G was at the forefront of cellular technology as. on average, the speed of data transmission on 3G networks on average could reach 8Mbps, as opposed to 64kbps for a 2G network. Unfortunately for EXCL, it fell victim to accelerating change (observed exponential nature of the rate of technological change), whereby 4G (average transmission speed of 50Mbps) technology adoption accelerated at an unforeseen pace.

Given the advent of affordable 4G compatible smartphones, use cases of 4G exponentially grew. This coincided with a boom in technology services such as ride hailing and e-commerce which require a 4G connection to work.

EXCL’s massive capex spending on 3G, left it with declining operating income (1Q15-3Q21) (Fig. 5) and FCF (1Q13-4Q19) (Fig. 7). It also led to massive network write-downs for the company. On the other hand, operators like Telkomsel (TSEL, unlisted) and Indosat (ISAT IJ, Buy), which did not aggressively push their 3G network, were able to rebound and ride the 4G wave.

We believe that the decade of doldrums for EXCL is over. From its peak of 54,138 3G BTS in 1Q20, EXCL as of 1H24 only has 377 3G BTS left (Fig. 2-3). The tower sites that in the past held 3G BTS was converted by EXCL to hold 4G BTS in a move known as spectrum re-farming. As a result of this initiative, EXCL’s 4G BTS rose to 109,170 as of 1H24 (Fig. 3), and its network quality and coverage expanded exponentially. This coincided with the company’s aggressive (and successful) entry into the ex-Java region, where EXCL has earned significant market share gains given TSEL’s premium pricing in the region.

Due to the above, we expect operational improvements for EXCL. Operationally we expect improving trends at the revenue (Fig. 4), operating income (Fig. 5), and profit (Fig. 6) levels of EXCL. Whereby in 2019 EXCL booked an operating income loss, the company has seen steady growth in operating income for 4Q21-1H24 (Fig. 5). Moreover, FCF for the company has returned to healthy levels for 1Q23-1H24 (Fig. 7). While indeed ISAT has seen the most benefit from expanding the ex-Java market due to its superior spectrum market share, we believe that EXCL’s growth parallels that of ISAT, albeit at a smaller scale. Given 2024F EV/EBITDA for EXCL at 4.12x vs ISAT at 5.0x, we believe that there is room for EXCL to re-rate. Hence, we reiterate our Buy call on EXCL.

Valuations and risks

We derive our TP of IDR2,600 based on DCF analysis, using a risk-free rate of 6.2%, an equity risk premium of 7.4%, and a terminal growth rate of 2.5%. This results in a WACC of 9.4%. At our TP, the stock would trade at 2024F EV/EBITDA of 4.12x (compared to 3.9x at the current price). Downside risks include adverse macro conditions, lower customer spending, less service price hikes leading to lower data prices, irrational competition behavior, and/or higher opex.