RCOM- Another weak quarter, on expected lines- Kotak Sec

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Reliance Communications (RCOM)
Telecom
Another weak quarter, on expected lines. SELL. RCOM’s struggle to grow revenues
(across wireless and non-wireless business lines) continued in 2QFY11 with the
company reporting flat qoq overall revenues (down 10% yoy), 3% below estimates.
Aggressive cost control aided the company meet our EBITDA estimate and tax writeback
led to better-than-expected PAT. A stretched balance sheet (net debt to TTM
EBITDA now at 4.3X) in addition to revenue woes keep us negative on the stock. SELL.

Weak 2QFY11; revenue growth challenge continues
RCOM reported revenues, EBITDA, and net income of Rs51.2 bn (3% below estimate, +0.2% qoq,
-10% yoy), Rs16.6 bn (in line with estimate, +2% qoq, -18% yoy), and Rs4.5 bn (37% above
estimate, -40% yoy) for 2QFY11. Even as the company managed to meet our EBITDA estimate
despite revenue miss through aggressive cost controls (overall costs declined in absolute terms), tax
write-back of Rs661 mn led to the reported net income outperformance.

Revenue performance disappointed across the board – wireless segment revenues were flat qoq at
Rs41.6 bn (+3.8% yoy). Minutes growth trend (+0.2% qoq to 94.6 bn) was in line with Bharti,
Idea, and Vodafone – reflecting weak seasonality and some loss of minutes market share. We do
note that RCOM’s minutes trend is not 100% a reflection of industry trends on account of
additional pressure from declining PCO base and struggling CDMA segment. The company missed
revenue estimates in the LD and BB segments as well.

Balance sheet remains stretched
Exhibit 2 depicts the end-Sep 2010 balance sheet of RCOM – net debt to ttm EBITDA now stands
at 4.3X, while net debt to annualized Sep quarter EBITDA is at 4.4X, stretched in our view. The
company has announced steps and made attempts to reduce balance sheet leverage through asset
sale as well as fresh equity infusion at the parent company level, without success so far. We also
note that fresh capital infusion into the company could turn out to be only a temporary relief
unless the company improves on execution and delivers better turnover of its massive asset base.

Reiterate SELL; will review estimates and target price post the earnings call
We shall review our EPS estimates post the company’s earnings call. We continue to find RCOM in
a very challenging situation—battle for India’s wireless business share continues to be fierce and
the company is saddled with a stretched balance sheet and network disadvantage (lower # of cell
sites, and a 1,800 MHz spectrum in most circles) versus leading incumbents. Valuations do not yet
lend comfort in the wake of structural risks facing the industry and the company’s weak balance
sheet. We maintain our SELL recommendation on the stock.