Tata Communications' (TCom) Q2FY21 EBITDA (excl. real estate revenues) came in at Rs11bn (I-Sec: Rs10bn), up 41% YoY. It benefited from higher EBITDA margins in Traditional services (~44.7%) and in Growth services. GDS revenue growth was muted at 7.2% YoY (1.1% QoQ); however, management has been confident (mentioned it multiple times on call) of strong delivery in revenue growth based on strong sales funnel, which continues to grow. Management however cautioned on back-ended costs and unsustainable margins. TCom has generated healthy FCF (> PAT) and organic deleveraging of 4.2% of net debt in Q2FY21, which is impressive, but we will wait to see the trend sustain. We have increased our EBITDA estimates by 8.3% / 13.5% for FY21E / FY22E on higher margins, and accordingly raised our target price to Rs1,014 (from Rs830). Maintain ADD though we see more valuation rerating if the company delivers strong revenue growth as well.
- GDS net revenue grew 3.3% QoQ while total was muted 1.2%: We would hereon closely track net revenue (total revenue minus direct cost), which is more representative of underlying performance for TCom (like AGR for mobile services). GDS net revenue grew 7.4% YoY (+3.3% QoQ) to Rs23.5bn driven by strong 28% increase in Growth services (incl. Innovative services) to Rs4.6bn. Traditional services' revenue grew 6.1% YoY (+2.8% QoQ) to Rs18.5bn. Total GDS revenue grew 7.1% YoY (+1.2% QoQ) to Rs36bn. The higher net revenue can be attributed to strong growth in NPL and IP-T in Traditional services, and media and security services in Growth segment, which has lower direct cost (unlike past two quarters, which were driven by UCC/SIP-T that has higher direct costs). Further, international enterprise saw some traction and grew 16.4% YoY (vs enterprise revenue growth of 12.4% YoY).
- Traditional services' margins continue to surprise positively on lower cost: Costs have been benefited from: 1) Covid-related savings such as travel, etc. of Rs500mn (since Q1FY21); and 2) Rs430mn cost has been pushed to H2FY21. Besides, TCom has been working on realigning costs to the changing business model, which has led to Traditional services' EBITDA margin expanding to 44.7% (vs 37.8% in Q2FY20). Adjusted for one-off cost benefits, EBITDA margin is still encouraging at 40.6%. Growth services' (incl. Innovative services) EBITDA improved to Rs700mn (up 5x QoQ) on strong contribution from media and security services. TCTS and ATM businesses together reached EBITDA breakeven vs loss in Q1FY21, but continue to be under pressure. TCom's reported EBITDA jumped 40.5% YoY to Rs11bn driven by GDS EBITDA growth of 50% to Rs10.6bn.
- FCF generation improves; organic deleveraging begins: Capex is under control at Rs3.2bn (capex intensity: 7.3%). TCom had received Rs674mn and Rs500mn from sale of land parcel and international fiber asset respectively, offsetting staff optimisation cost of Rs1bn and dividend payout of Rs1.4bn. Yet, the company's net debt has dipped Rs3.8bn (4.2% of total cost in Q2FY21), which indicates strong FCF generation. Notably, tax rate may remain low due to accumulated losses in international business, which has turned PBT positive and further boosted FCF.
- TCom management has strongly emphasised a strong sales funnel pipeline, which is also witnessing healthy growth, in GDS. Though India has seen better deal conversion, supply-chain and logistical issues hurt revenues. In the international market, deal conversions are getting delayed due to Covid. Management remains confident on sales funnel converting to orders / revenues in coming quarters.
- Innovation portfolio is seeing good momentum with NetFoundry picking up and expected to deliver sustained growth. India IOT has delivered good results and growth would continue. On MOVE (cross-border IOT), the company has seen interest from a few new customers like semiconductor companies for use in their products.
- TCom has been working on realignment its operating model with changing business model. The total cost-saving of Rs2bn is sustainable while Rs500mn cost-saving (Covid-led) would be reversed on market normalisation. Management has guided for EBITDA margin of 22-25% in GDS, but we see reasonable scope for outperformance on expected acceleration in revenue growth and likely expansion of Growth services' margins.
- Staff cost optimisation exercise is likely to end in the next few months. Employee mix is likely to improve on change in offshore-onshore ratio to 53:47 from earlier 61:29.
- Company expects revenue growth to accelerate in TCTS with execution of international order wins, which should drive further improvement in TCTS profitability.
- Company has a hurdle rate of 20% for incremental investment / capex.
- It is looking to monetise a few assets including some land parcels, etc.
Shares of TATA COMMUNICATIONS LTD. was last trading in BSE at Rs.921.45 as compared to the previous close of Rs. 877.6. The total number of shares traded during the day was 57803 in over 652 trades.
The stock hit an intraday high of Rs. 921.45 and intraday low of 918.2. The net turnover during the day was Rs. 53262431.