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Defensive No More
We initiate coverage on the Indian telecom sector with Sell ratings on Bharti
Airtel and Idea Cellular and a Hold rating on Reliance Communications (RCOM).
Bharti and Idea have outperformed the Sensex over the past one year, partly on
optimism generated by tariff hikes. However, in our view, current stock prices do
not adequately factor in high leverage, regulatory risk, slowing subscriber
addition and low returns on capital. Thus, we see little scope for upside going
forward. It should be noted that our FY13 EPS estimates are below consensus
estimates for Bharti, Idea and RCOM by 17.7%, 11.9% and 12.3%, respectively.
Stocks outperform due to tariff hikes; leverage, regulatory risks not factored in:
Bharti Airtel and Idea Cellular have outperformed the BSE Sensex by 15% and 39%,
respectively, over the past one year, as the perception is these stocks are defensive
bets and optimism generated by tariff hikes enabled them to remain resilient amid
turbulent market conditions. We believe tariff hikes are unlikely to sustain given the
Telecommunications Regulatory Authority of India’s (TRAI) aversion to such steps by
operators, apart from the likelihood that even in the event of consolidation the market
will still be fairly competitive, thereby preventing any structural upside in tariff. Apart
from this, we believe a significant rise in financial leverage, intangibles and
regulatory risks including ‘excess spectrum’ charges and licence renewal risks
have not been adequately factored in current share prices. Regulatory risks
account for 11-35% of the current market capitalisation for Bharti and Idea.
Slowdown in subscriber addition reflects rising saturation: Over the past few
months, the industry’s net subscriber addition fell significantly, from over 20mn
in March 2011 to just 7.8mn in October 2011, as per TRAI data. This, we believe,
is a clear sign that the Indian telecom market is nearing saturation point and
going forward, net subscriber addition will continue to taper down steadily.
Therefore, companies need to drive revenue growth through new services like 3G.
However, in our view, 3G is likely to take time to ramp up and attempting to sustain
revenue growth through tariff hikes is unlikely to be an easy task either.
Returns on capital employed at a multi-year low: Due to significant fund
requirements of telecom companies in FY11 owing to spectrum auctions and poor
financial performance because of price wars, return on equity (RoE) and return on
capital employed (RoCE) declined to multi-year lows. Going forward, we do not expect
a significant improvement in performance on this front. In fact, we expect Idea and
RCOM to register single-digit RoE and RoCE even in FY13, not even equal to
their cost of capital.
We assign Sell ratings to Bharti and Idea, Hold to RCOM: We assign Sell ratings to
Bharti and Idea, while we have a Hold rating on RCOM. Rise in financial leverage,
regulatory risks, multi-year low returns on capital and slowing subscriber growth are
common threads connecting all these companies and we believe this is not adequately
factored into current stock prices. Faster-than-expected monetisation of tower assets,
which would enable deleveraging and thus improved financial metrics and valuations,
are key upside risks to our negative view on the sector. It should be noted that our
FY13 EPS estimates are below consensus estimates for Bharti, Idea and RCOM
by 17.7%, 11.9% and 12.3%, respectively.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Defensive No More
We initiate coverage on the Indian telecom sector with Sell ratings on Bharti
Airtel and Idea Cellular and a Hold rating on Reliance Communications (RCOM).
Bharti and Idea have outperformed the Sensex over the past one year, partly on
optimism generated by tariff hikes. However, in our view, current stock prices do
not adequately factor in high leverage, regulatory risk, slowing subscriber
addition and low returns on capital. Thus, we see little scope for upside going
forward. It should be noted that our FY13 EPS estimates are below consensus
estimates for Bharti, Idea and RCOM by 17.7%, 11.9% and 12.3%, respectively.
Stocks outperform due to tariff hikes; leverage, regulatory risks not factored in:
Bharti Airtel and Idea Cellular have outperformed the BSE Sensex by 15% and 39%,
respectively, over the past one year, as the perception is these stocks are defensive
bets and optimism generated by tariff hikes enabled them to remain resilient amid
turbulent market conditions. We believe tariff hikes are unlikely to sustain given the
Telecommunications Regulatory Authority of India’s (TRAI) aversion to such steps by
operators, apart from the likelihood that even in the event of consolidation the market
will still be fairly competitive, thereby preventing any structural upside in tariff. Apart
from this, we believe a significant rise in financial leverage, intangibles and
regulatory risks including ‘excess spectrum’ charges and licence renewal risks
have not been adequately factored in current share prices. Regulatory risks
account for 11-35% of the current market capitalisation for Bharti and Idea.
Slowdown in subscriber addition reflects rising saturation: Over the past few
months, the industry’s net subscriber addition fell significantly, from over 20mn
in March 2011 to just 7.8mn in October 2011, as per TRAI data. This, we believe,
is a clear sign that the Indian telecom market is nearing saturation point and
going forward, net subscriber addition will continue to taper down steadily.
Therefore, companies need to drive revenue growth through new services like 3G.
However, in our view, 3G is likely to take time to ramp up and attempting to sustain
revenue growth through tariff hikes is unlikely to be an easy task either.
Returns on capital employed at a multi-year low: Due to significant fund
requirements of telecom companies in FY11 owing to spectrum auctions and poor
financial performance because of price wars, return on equity (RoE) and return on
capital employed (RoCE) declined to multi-year lows. Going forward, we do not expect
a significant improvement in performance on this front. In fact, we expect Idea and
RCOM to register single-digit RoE and RoCE even in FY13, not even equal to
their cost of capital.
We assign Sell ratings to Bharti and Idea, Hold to RCOM: We assign Sell ratings to
Bharti and Idea, while we have a Hold rating on RCOM. Rise in financial leverage,
regulatory risks, multi-year low returns on capital and slowing subscriber growth are
common threads connecting all these companies and we believe this is not adequately
factored into current stock prices. Faster-than-expected monetisation of tower assets,
which would enable deleveraging and thus improved financial metrics and valuations,
are key upside risks to our negative view on the sector. It should be noted that our
FY13 EPS estimates are below consensus estimates for Bharti, Idea and RCOM
by 17.7%, 11.9% and 12.3%, respectively.
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