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Leverage, low returns on capital to limit upside
Given Reliance Communications’ (RCOM) worsening operating and financial
metrics over the past several quarters, likely single-digit returns on capital even
until FY13, slowdown in incremental subscriber addition, low active subscriber
proportion compared with peers and low 2G revenue coverage of 56.6%, we see
little scope for significant appreciation in its share price. Nonetheless, further
downside may be limited owing to a steep 45% decline over the past one year.
We assign a Hold rating to the stock with a target price of Rs86. It should be
noted that our FY13 EPS estimate is 12.3% below consensus estimates.
High financial leverage; deleveraging depends on tower stake sale: At the end of
FY11, RCOM’s net debt-equity ratio stood at 0.8x (0.6x in FY10) and net debt-EBITDA
ratio at 3.7x (3.2x in FY10). The respective figures at the end of 2QFY12 rose to 0.9x
and 5x, respectively. As much as Rs173.8bn of debt is due for repayment in FY12. A
major repayment due is in respect of foreign currency convertible bonds (FCCBs)
issued in February 2007. Including interest costs, the outstanding amount is
US$1.15bn (Rs62.1bn at current FX rates). We expect RCOM to borrow Rs60bn to pay
back FCCB holders. Assuming a 10% interest rate for incremental debt, this
translates into incremental interest costs of Rs3bn for swapping FCCB debt with
rupee debt. This has an adverse impact of 21.4% on our FY12 PBT estimate. We
believe the best way for RCOM to deleverage is by selling stake in its tower business,
Reliance Infratel. However, given the challenging market and economic conditions, this
is likely to be a tall order. Funding debt repayment through equity issuance is also likely
to be a challenging task under difficult market conditions and a 45% fall in its share
price over the past one year.
Single-digit returns on capital likely to continue until FY13: Post-FY09, RoE and
RoCE steadily deteriorated, particularly post the tariff wars witnessed after October
2009. RoE and RoCE in FY11 stood at just 3.2% and 3.3%, respectively, which is
considerably below the average cost of capital of over 10%. Even going forward, we
expect RoE to be a mere 2.3% in FY12 before recovering to 3% in FY13, while we
expect RoCE to decline to 3% in FY12 before moving up slightly to 3.7% in FY13.
Therefore, we expect RCOM’s return ratios to remain sub-standard until FY13.
Valuation: We assign an EV/EBITDA multiple of 4.5x to RCOM, an 18% discount to
Bharti Airtel and arrive at a valuation of Rs28/share, while we value Reliance Infratel at
a 50% discount to book value given the low third party tenancies, which translates into
Rs58/share. Thus, we arrive at a TP of Rs86, implying 11% upside from the current
market price. We thus assign a Hold rating to RCOM with a target price of Rs86
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Leverage, low returns on capital to limit upside
Given Reliance Communications’ (RCOM) worsening operating and financial
metrics over the past several quarters, likely single-digit returns on capital even
until FY13, slowdown in incremental subscriber addition, low active subscriber
proportion compared with peers and low 2G revenue coverage of 56.6%, we see
little scope for significant appreciation in its share price. Nonetheless, further
downside may be limited owing to a steep 45% decline over the past one year.
We assign a Hold rating to the stock with a target price of Rs86. It should be
noted that our FY13 EPS estimate is 12.3% below consensus estimates.
High financial leverage; deleveraging depends on tower stake sale: At the end of
FY11, RCOM’s net debt-equity ratio stood at 0.8x (0.6x in FY10) and net debt-EBITDA
ratio at 3.7x (3.2x in FY10). The respective figures at the end of 2QFY12 rose to 0.9x
and 5x, respectively. As much as Rs173.8bn of debt is due for repayment in FY12. A
major repayment due is in respect of foreign currency convertible bonds (FCCBs)
issued in February 2007. Including interest costs, the outstanding amount is
US$1.15bn (Rs62.1bn at current FX rates). We expect RCOM to borrow Rs60bn to pay
back FCCB holders. Assuming a 10% interest rate for incremental debt, this
translates into incremental interest costs of Rs3bn for swapping FCCB debt with
rupee debt. This has an adverse impact of 21.4% on our FY12 PBT estimate. We
believe the best way for RCOM to deleverage is by selling stake in its tower business,
Reliance Infratel. However, given the challenging market and economic conditions, this
is likely to be a tall order. Funding debt repayment through equity issuance is also likely
to be a challenging task under difficult market conditions and a 45% fall in its share
price over the past one year.
Single-digit returns on capital likely to continue until FY13: Post-FY09, RoE and
RoCE steadily deteriorated, particularly post the tariff wars witnessed after October
2009. RoE and RoCE in FY11 stood at just 3.2% and 3.3%, respectively, which is
considerably below the average cost of capital of over 10%. Even going forward, we
expect RoE to be a mere 2.3% in FY12 before recovering to 3% in FY13, while we
expect RoCE to decline to 3% in FY12 before moving up slightly to 3.7% in FY13.
Therefore, we expect RCOM’s return ratios to remain sub-standard until FY13.
Valuation: We assign an EV/EBITDA multiple of 4.5x to RCOM, an 18% discount to
Bharti Airtel and arrive at a valuation of Rs28/share, while we value Reliance Infratel at
a 50% discount to book value given the low third party tenancies, which translates into
Rs58/share. Thus, we arrive at a TP of Rs86, implying 11% upside from the current
market price. We thus assign a Hold rating to RCOM with a target price of Rs86
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