Zee Entertainment Enterprises - Operating margins at risk - Kotak

We recently interacted with the Mr. Kanwaljeet Singh- AVP-Business Development & Corporate Strategy of ZEEL to get the latest update on the company. The key highlights were:

- Ad growth to remain muted: In FY13 ZEEL had 24%YoY growth in ad revenues on the back of gain in market share and rating improvement across channels especially ZEE TV. However, lately ZEE TV has been losing market share in the prime time slot while remaining flat overall. In regional channels, the company has done relatively better by either maintaining or gaining market share across genres. TRAI's ad cap (10+2mins) mandate could further impact the company as it has to cut its ad inventory by ~20-25% across networks. We believe the increase in ad rates will not be enough to mitigate this fall in inventory as the company will have 10-15% inventory sold in long term deals. Management believes that though they had voluntarily cut inventory in Zee Cinema in FY13, they managed the desired growth rate in the channel. With industry ad growth at 7-9% in FY14, we do not expect ZEEL to significantly outperform the industry on the back of higher base coupled with risk from TRAI's ad cap regulation.

- Investment in new businesses: In FY13, ZEEL incurred Rs1.5bn losses on the back of investment in new businesses and channels. The company launched many channels including Ten Golf, Zee Alwan, Zee Bangla Cinema, Zee Q, HD channels and Ditto TV. In FY14, the company is expected to launch a few more channels along with higher investments in launched channels in FY13. With FY14 being the full year of operations for these channels we expect losses in new businesses to be higher than Rs1.5bn which could impact operating margins. The company is also planning to invest in new programming on its current channels to increase market share and rating which could further increase programming cost.

- Losses in sports to expand: In FY14, Ten Sports is expected to broadcast 3 cricket series in which India is expected to play India-Sri Lanka-West Indies Tri Series (7 ODI), India-Zimbabwe (5 ODI) and India-South Africa (3 Test, 7 ODI, 1 T20). Sports subscription revenues do not increase in tandem with the high content cost which widens losses in India Series. Coupled with this, Rupee depreciation will further increase losses. We have modelled losses of Rs1150mn for FY14 against Rs870mn in FY13.

- Subscription revenue growth to moderate: Management expects domestic subscription revenues to grow by 15-17% for FY14E against 26.3% in FY13. Though the impact of Phase-II digitization will come in FY14, subscription revenue growth from Phase-II will be lower for ZEEL as monetization from Phase-II markets was higher than Phase-I markets pre-digitization. They expect strong growth from Phase-III and Phase-IV markets which will yield benefit only in FY16. Currently, the company is earning only negligible revenue from Phase-IV markets. International subscription revenues are expected to grow by mere 1-3%YoY in FY14 in constant currency terms as European market is continuing to de-grow. The company however grew in US, Africa and APAC markets. Rupee depreciation could help the company increase growth to high single digits.

- Reducing Estimates: We are marginally reducing revenues by 0.9% and 2% for FY14E and FY15E respectively on the back of lower expectations on subscription revenues. Operating profits are being reduced by 7.2% and 5.9% for FY14 and FY15 for higher losses in sports, new ventures and higher programming cost. Lower operating revenues would result in PAT reduction by 5.2% and 5% respectively. We expect revenues to grow at a CAGR of 13.9% over FY13-15E and PAT by 14%. Operating margins will decline by 69bps in FY14.

- Valuations: The stock currently trades at 30.3x and 25.3x FY14E and FY15E EPS of Rs8.16 and Rs9.8 respectively. We continue to value the stock at 25x FY15 and arrive at a target price of Rs245 and maintain our Neutral view on the stock. Near term uncertainties on advertisement growth, higher loss in sports coupled with increasing programming cost would impact the stock. However we continue to remain bullish on subscription revenue growth over the long term.

Source : Equity Bulls

Keywords