Telecom - Focus on profitability is returning - Avendus

The tariff rise of up to 25% in four circles during Sep12 is yet another sign of waning competitive intensity. Profitability and earnings may also improve by the recent decline in subscribers. Expansion in the subscriber base during 1H2012 had lifted SG&A costs, eroding profitability. These developments may halt the long erosion in profit forecasts and improve the outlook for the valuation of telecom stocks. We reduce valuation discount for IDEA's and RCOM's target one-year forward EV/EBITDA to that of BHARTI and raise the Sep13 TPs to INR90 and INR66, respectively. Maintain Buy on BHARTI, and Hold on IDEA and RCOM. We stay positive on the telecom sector with BHARTI as the preferred pick. Our Sep13 TP includes the impact of likely regulatory levies like free roaming, renewal and refarming.

Scattered tariff hikes point to fall in competitive intensity

RCOM may have raised tariffs by 25% in four circles, i.e., Madhya Pradesh, Himachal Pradesh, Bihar and Gujarat. IDEA may have also hiked tariffs in Madhya Pradesh by 15%-20%. While the tariff rises may have been only in select circles, the pricing revival indicates an easing competitive intensity. A 10% increase in outgoing voice tariffs for pre-paid and post-paid subscribers is likely to raise the consolidated average revenue per minute (ARPM) by up to 4.5%. Assuming no loss in minutes compared to current forecasts, the rise in ARPM may improve FY14f earnings by up to 21% for BHARTI, 73% for IDEA and 47% for RCOM.

Decline in subscribers may improve profitability and earnings

Profitability may improve, as the drop in gross subscriber additions is likely to imply lower SG&A costs. A decrease in subscribers during Aug12 may reflect lower gross additions, assuming churn rates may have remained constant. Channel payouts, which are included in SG&A costs, are likely to be based on gross subscriber additions. Moreover, the subscriber additions in Jan12-Jun12 were less profitable. Hence, the reduction in subscribers during recent months may imply better profitability and earnings. We expect EBITDA margins for BHARTI to improve by 114-bp during FY14f-FY15f and 40-bp for IDEA.

Earnings forecasts likely to bottom out

The earnings outlook may improve with the pricing revival and likely higher profitability. Earlier tariff hikes in Jul11 led to an improvement in consensus earnings forecasts; however, increasing competition in 2HFY12 led to downgrades. We reduce the discounts of IDEA and RCOM's one-year forward EV/EBITDA to that of BHARTI from 10% and 40% to 0% and 30%, respectively.

Large room to regain value; prefer BHARTI

We maintain our forecasts, but raise our Sep13 TP for IDEA to INR90 and RCOM to INR66, as the earnings outlook may lead to better valuations. We maintain our rating of Buy on BHARTI, and Hold on IDEA and RCOM. We remain positive on the telecom sector with BHARTI as the preferred pick. Our Sep13 TP includes the impact of likely regulatory levies like free roaming, renewal and refarming.

Source : Equity Bulls

Keywords