J.P. Morgan -Idea Cellular Limited

Idea Cellular Limited (IDEA IN) Robust quarter with clean beat across the board driven by solid MoU & subs growth; ARPM movement needs watching; stay OW		Overweight Price: Rs140.45 25 Apr 2014 Price Target: Rs170.00 PT End Date: 31 Dec 2014

Idea (OW) reports another impressive quarter with robust revenue/minutes growth, significant increase in MoUs/ARPUs, solid data revenue growth, meaningful decline in churn and higher-than-expected margin expansion.The company delivered a clean beat on our and consensus estimates on all counts, emanating right up from revenues to EBITDA/margins and PAT/EPS. We continue to like Idea (OW) due to its consistently strong operational performance driven by subscriber and revenue market share gains. However, pricing (ARPM) moderated in Mar-14 and needs watching breaking the sequence of Q/Q ARPM improvement seen in the most recent three quarters. On expected lines, net debt to EBITDA increased from 1.2x (at the end of 3Q FY14) to 2.4x after accounting for Feb-14 auction spectrum payments and ‘deferred spectrum payment’ liabilities. The expected increase in competitive intensity due to Reliance Jio’s imminent entry in the market remains the key medium-to-longer term risk to our positive stance on Idea.

· Idea reports a strong quarter with impressive performance across the board. Revenues grew 6.5% Q/Q (vs. our and consensus estimate of 6.0% and 5.1%, respectively) and 16.2% Y/Y driven by solid minutes growth. In the seasonally strong March quarter, volumes/minutes grew 8.6% Q/Q primarily due to solid subscriber additions and 5.6% Q/Q increase in MoUs (from 376 in 3QFY14 to 397 in 4QFY14). Idea reports very robust subscriber additions during the quarter, adding about 2.4 mn subscribers every month (in other words, Idea added 7.2 million subscribers in Jan-Mar 2014 – the second highest quarterly additions in the last 12 quarters). Idea has the best-in-industry VLR ratio (proportion of active subs) with limited headroom for improvement. Hence, MoU growth looks rather clean/organic. Encouragingly, blended churn decreased meaningfully from 5.6% in 3Q FY14 to 4.2% in 4Q FY14, marking the lowest churn % in the last 22 quarters. Blended APRU increased 2.5% Q/Q to Rs173 (vs. Rs169 last quarter) driven by MoU growth. Data revenues grew 77% Y/Y, modestly ahead of our expectation. Data now accounts for 10.1% of revenues and 18.6% of the subscriber base (3G is a subset of this).

· ARPMs moderated slightly, breaking a sequence of Q/Q ARPM improvement for the past three consecutive quarters. The only weak point in 4Q FY14 was modest decline in ARPMs. Blended ARPMs decreased 3.0% Q/Q in Mar-14 quarter from 44.9 paisa to 43.6 paisa. We estimate voice ARPM decline of 2.4% Q/Q (balance 0.6% decline from data, data RMB has sharply declined 14% Q/Q, down 25% Y/Y). We expect data pricing to moderate to drive data adoption. However, blended ARPMs are still up 9.2% Y/Y due to healthy increase over the previous three quarters (1QFY14 to 3QFY14). We believe ARPM decline in 4Q FY14 might be a quarterly aberration, but that said, ARPM movement needs watching.

· Healthy EBITDA margin expansion driven by volume growth. EBITDA margins increased 60bp Q/Q (vs our/consensus expectation of a 30/20bp increase) from 31.1% in 3Q FY14 to 31.7% in 4Q FY14, primarily due to strong revenue growth (operating leverage) and lower-than-expected network operating & employee costs. Idea reported 4Q FY14 PAT of Rs5.9 billion, ~13% ahead of our estimate. Net debt to EBITDA increased from 1.2x (at the end of 3Q FY14) to 2.4x after accounting for Feb-14 auction spectrum payments and deferred spectrum payment liabilities.

· Idea expects FY15 capex to be flattish Y/Y at about Rs35 billion (ex any spectrum payout) – this means that FY15 capex (as % of sales) is moderating. Notably, the company invested Rs35.2 billion in capex in FY14. 4Q FY13 capex was at Rs12.9 billion. We expect capex to pick up in the medium-to-longer term as data consumption accelerates.

· Investment view: We stay OW on Idea given its sustained impressive performance, market share gain prowess in a consolidating market and strong (than peers) balance sheet. We see Idea’s financials improving on both counts: margins & consistent market share gains. That said, we admit Reliance Jio’s imminent entry has the potential to disrupt the Indian telecom industry and remains the key risk for our Idea rating and price target. But we see that as potentially a medium-to-long term threat.

· Conference call: Tuesday, April 29 at 2.30 pm India time. Dial in details: India: +91-22-6746 5817/ +91-22-3960 0817; Hong Kong + 800 964 448, Singapore + 800 101 2045; UK +0 808 101 1573; USA +1 866 746 2133.

Table 1: Financial metrics

Rs in millions, year-end March

	4QFY14	4QFY14E	4QFY14E	Actual vs.	Actual vs.		%		%
	Actual	JPMe	Cons	JPMe	cons.	3QFY14	Q/Q	4QFY13	Y/Y
Revenue	70,438	70,073	69,509	0.5%	1.3%	66,131	6.5%	60,614	16.2%
Interconnection cost	(11,011)	(10,672)		3.2%		(10,090)	9.1%	(10,770)	2.2%
License fee and spectrum	(7,582)	(7,607)		-0.3%		(7,232)	4.8%	(7,191)	5.4%
Network operating costs	(17,270)	(17,456)		-1.1%		(16,423)	5.2%	(14,298)	20.8%
Employee Costs	(3,121)	(3,528)		-11.6%		(3,445)	-9.4%	(2,976)	4.9%
SG&A	(7,368)	(7,257)		1.5%		(6,890)	6.9%	(7,100)	3.8%
Other	(1,784)	(1,542)		15.7%		(1,495)	19.4%	(1,549)	15.2%
Total operating expense	(48,137)	(48,061)		0.2%		(45,574)	5.6%	(43,883)	9.7%
EBITDA	22,302	22,012	21,742	1.3%	2.6%	20,557	8.5%	16,731	33.3%
margin (%)	31.7%	31.4%	31.3%	0.25pp	0.4pp	31.1%	0.6pp	27.6%	4.1pp
D&A	(11,380)	(11,755)		-3.2%		(11,666)	-2.4%	(9,092)	25.2%
EBIT	10,921	10,256	9,841	6.5%	11.0%	8,891	22.8%	7,639	43.0%
margin (%)	15.5%	14.6%	14.2%	0.87pp	1.3pp	13.4%	2.1pp	12.6%	2.9pp
Interest expense (net)	(1,966)	(1,901)		3.4%		(1,575)	24.8%	(2,244)	-12.4%
Profit before tax	8,956	8,356	8,021	7.2%	11.7%	7,316	22.4%	5,395	66.0%
Net income	5,898	5,431	5,195	8.6%	13.5%	4,677	26.1%	3,082	91.4%
EPS (INR)	1.78	1.64	1.57	8.5%	13.2%	1.41	26.0%	0.93	91.1%
Capex	12,945	23,396		-44.7		10,201	26.9%	13,280	-2.5%
Capex/sales (%)	18.4%	33.4%		-1500.2%		15.4%	3.0pp	22%	-3.4pp

Source: Company reports, J.P. Morgan estimates, Bloomberg.

Table 2: Operational metrics

YE Mar.	4QFY14	4QFY14E	Actual vs.		%		%
	Actual	JPMe	JPMe	3QFY14	Q/Q	4QY13	Y/Y
Subscribers ('000s)	135,788	135,788	0.0%	128,685	5.5%	121,607	11.7%
Net adds ('000s)	7,103	7,103	0.0%	1,457	387.6%	7,661	-7.3%
Net adds per month ('000s)	2,368	2,368	0.0%	486	387.6%	2,554	-7.3%
Pre-paid share in base (%)	95.7%	95.7%	0.00pp	95.7%	0.00pp	96.1%	-0.40pp
Churn (%)	4.2%	5.4%	-1.2pp	5.6%	-1.4pp	4.3%	-0.1pp
Minutes (mn)	157,055	151,400	3.7%	144,571	8.6%	143,366	9.5%
Q/Q minutes growth	8.6%	4.7%	3.9pp	4.1%	4.5pp	8.5%	0.2pp
Voice ARPM (paisa)(calculated)	37.4	38.6	-3.0%	38.4	-2.4%	36.1	3.8%
MOU (minutes per month)	397	382	4.0%	376	5.6%	406	-2.2%
ARPU (INR)	173	173	-0.1%	169	2.4%	167	3.6%
Blended ARPM (paisa) reported	43.6	45.4	-4.0%	44.9	-3.0%	41.1	5.9%
VAS as a % of revenue	16.5%	16.4%	0.1pp	16.1%	0.4pp	15.2%	1.3pp
3G subs	10.2	10.5	-3.2%	8.7	17.2%	5.1	100.0%
Data as a % of revenues	10.1%	9.8%	0.3pp	9.5%	0.6pp	6.6%	3.5pp
Revenue break-up (INR m)
Standalone	70,406	69,893	0.7%	66,105	6.5%	60,952	15.5%
Indus	5,735	5,786	-0.9%	5,645	1.6%	5,620	2.0%
Eliminations	(5,703)	(5,606)	1.7%	(5,620)	1.5%	(5,958)	-4.3%
Total	70,438	70,073	0.5%	66,131	6.5%	60,614	16.2%
EBITDA break-up (INR m)
Standalone	19,881	19,529	1.8%	18,135	9.6%	15,038	32.2%
Indus	2,420	2,483	-2.5%	2,422	-0.1%	1,693	43.0%
Total reported	22,302	22,012	1.3%	20,557	8.5%	16,731	33.3%
EBITDA Margin (%)
Standalone	28.2%	27.9%	0.3pp	27.4%	0.8pp	24.7%	3.6pp
Indus	42.2%	42.9%	-0.7pp	42.9%	-0.7pp	30.1%	12.1pp
Total reported	31.7%	31.4%	0.2pp	31.1%	0.6pp	27.6%	4.1pp

Source: Company reports, J.P. Morgan estimates.

We will review our estimates after the conference call.

 

Investment Thesis

Idea is the strongest operational play in the India telecom sector, in our view. The company has consistently gained subscriber and revenue market share over the last several quarters. Though Idea's current revenue market share is about 16%, its incremental revenue market share is about 30% over the last few quarters. The company has good presence in Category A and Category B circles, which will likely drive growth in the coming quarters. Idea is a pure-play telecom operator and therefore, we believe, will be a clear beneficiary of improvements in the sector in terms of the return of pricing power, data growth and relatively moderate competitive intensity. The entry of Reliance Jio is a key risk, but Idea is relatively well positioned to counter this threat, in our view.

Valuation

We retain our OW rating on Idea Cellular with a Dec-14 price target of Rs170. Our PT is based on a DCF valuation of Rs195 for the core business and Rs15 for Idea’s 16% stake in tower assets (Indus Towers), minus Rs40 for the NPV of expected spectrum payments. Our value of the core business is unchanged. We use a WACC of 11.5% and a terminal growth rate of 5%. Our PT implies 8.2x EV/EBITDA multiples based on FY15E EBITDA, prior to adjusting for regulatory costs. After adjusting for regulatory costs, EV/EBITDA stands at ~6.0x of FY15E EBITDA.

Risks to Rating and Price Target

Downside risks include: (1) the entry of RIL (Reliance Limited) into the voice market and disruptive market share gain practices by the company; (2) no increases in effective pricing due to increased competitive intensity; (3) “new circles” remaining a drag on profitability; and (4) a negative judgment in the Spice merger case.

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