Sell Bharti Airtel - Elara Capital

• Bharti Airtel
• Rating : Sell
• Target Price : INR330
• Downside : 10%
• CMP : INR366 (as on 21 September 2010)

FY12: Priced to perfection

Short term: Much of good news priced in

We believe the sentimental rally (as we expected relief rally in our note post 3G– In live wire mode) from the lows of post 3G spectrum auction for the stock is over, and at CMP the stock is fully pricing for the FY12 earnings (8xEBITDA). Further, seen from those low points, ~50% movement in the stock has not been associated with any meaningful earnings upgrade. According to our valuation, the best case scenario for Bharti on FY12 earnings is INR370 whereas the base case scenario is INR330; hence we believe, the stock doesn't offer any upside for the short-term (3-4months) unless market factors in FY13.

Slow consolidation process, tariff war is still in play

We think that the market is pricing in a quick consolidation in the telecom sector. There are encouraging signs in this direction, but the pace could be disappointing. We think the consolidation process could take another 18-24 months. Except few telecom operators (ie Bharti), most are looking to raise capital through strategic investments (Uninor, RCom, Idea, Shyam, Videocon) – a scenario that does not bode well for the reduction in the competitive intensity. On the tariff front, the reduction in tariff may have slowed down but has not reached the nadir. Success of Telenor's dynamic pricing offer (15-20% discount to 1paisa/sec tariff plan) highlights scope of further tariff cut.

Africa: Mounting operational and execution challenges

Africa offers huge growth scope – given its demographics and economic growth potential – but we believe Bharti would face serious competition from competitors. Further, there are many execution challenges (ie. tower sharing, change in business model) in the region, especially in key markets like Nigeria. According to our estimates, Africa would be EPS negative till FY12 and we expect a 32.5% EBITDA margin by FY13. We have factored in an EBITDA improvement in Zain assets at 0.5% on q/q sequential basis. Given the management's superior execution and cost efficiency record, there is a possibility that the company could positively surprise us, but we would like to see some evidence of that happening before we factor in our model.

Valuation: Target price at INR330

Having a net debt of ~3xEBITDA of FY11 (as of June'10), Bharti seems stretched. Last time when the company had balance sheet stretched to this extent, it took seven years for the company to deleverage with the EBITDA CAGR growth of 47%. With assumed EBITDA CAGR growth of 21% for the next three years, highlights that deleveraging would take much longer. We have valued the company on 7xFY12 EBITDA. If we factored in stretched target of Bharti (revenue of USD5bn and EBITDA of USD2bn for FY13), we achieve a target price of INR370 for FY12 earnings.

Source : Equity Bulls

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