4149In its 3Q14 update on the Kingdom’s telecom sector, NCB Capital, the GCC’s leading wealth manager and the Kingdom’s largest asset manager, believes the growing data segment and ongoing cost-cutting initiatives are the telecom sector’s near-term drivers while the attractive dividends yield of 4.3% is the sector’s key attraction.

“We expect the sector to record a revenue growth of 2% in 2014E and 4.7% in

2015E to reach SR82.6bn,” states Iyad Ghulam, Equity Research Analyst at NCB Capital. “Valuations remain attractive for STC and Mobily supported by strong fundamentals, dividend outlook and news on opening the TASI to international investors. We remain Overweight on STC and Mobily and Neutral on Zain.

“The slowdown in the sector is a key concern. The sector top-line is expected to grow 2% in 2014E and 4.7% in 2015E vs 3.8% in 2013. However, attractive valuation and high dividend yield compared to the market are the sector’s key

strengths. Our top pick is STC, driven by its strong balance sheet, potential of

higher dividends and attractive 2015E P/E of 12.0x.”

Frequent and high dividend yields are the sector’s key strength

NCB Capital believes frequent and high dividend yields are the sector’s key strength. The current dividend yield for the telecom sector is 4.3% compared to around 2.6% for the TASI. Also, STC and Mobily are among few companies in the market that pays quarterly dividends. Mobily 2014E DPS stands at SR5 representing a divided yield of 5.5% and a payout ratio at 59% while STC’s dividend yield and pay-out ratio are 4.1% and 52% respectively.

Data segment continues to drive the sector

“We believe growth in the sector will continue to be driven by the Data segment for the next two years, says Iyad Ghulam. “This is supported by higher penetration of low-cost smartphones. As per CITC, the number of subscribers grew by 42.5% YoY, as data penetration levels increased to 66%.”

Cost optimization is common in a maturing sector

NCB Capital’s 3Q14 update notes that, given the overall sector is moving towards maturity, companies are focusing on cost reduction initiatives. These initiatives improved EBIT margins by 232bps and 54bps at STC and Mobily, respectively, while reduced losses for Zain by 11.2% YoY for 2Q14. These measures are expected to help increase the sector’s earnings by 12% YoY in 2014E, despite only 2% growth in revenues.

Ratings Summary


Strong cash balance offers opportunities

“We remain Overweight on STC with a revised PT of SR84.8, states Iyad Ghulam. “We expect our 2014E net income to increase 16% YoY (4% on adjusted basis), led by lower costs and absence of one-off losses. Lower cost is expected to improve EBIT margin by 166bps in 2014E to 25.8%. Increasing competition and FX exposure remain key risks, while higher dividend potential and better-than-expected performance of international subsidiaries are key catalysts. We expect profitability to remain high in 2H14.”


High dividend yield offsets growth slowdown

NCB Capital remains Overweight on Mobily with the PT increasing 10% to SR104.9. “We expect the data segment to be the company’s growth driver, given its market-leading presence, says Iyad Ghulam. “Despite short-term challenges from the Atheeb deal cancelation and rising competition, we are positive on Mobily due to its attractive valuation and high dividend yield of 5.5%, which provides a downside support. We expect Mobily’s revenues to reach SR26.1bn in 2014E (up 3.7% YoY).”


Operating performance improvement to continue

“We remain Neutral on Zain with a revised PT of SR10.6,” states Iyad Ghulam. “The company is focusing on improving its top-line by increasing its broadband market share and enhancing margins by implementing cost optimization measures. Increasing competition and high depreciation remain key risks. We expect Zain to report a marginal 1.7% YoY rise in revenues for 2H14, driven mainly by the data segment.”

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