Telecom - Fundamentals improving - Tariffs improve, regulatory worries persist - BRICS Research

We believe outlook for stocks in BRICS telecom universe – Bharti and Idea - would continue to improve over 2012, led by progress in resolution of regulatory concerns starting with final version of New Telecom Policy (NTP) expected in early 2012 and Spectrum Act 2012. While tariff squeeze from high competitive intensity has tapered off, issues of regulatory uncertainty and leveraged balance sheet persist.

Rate realisation on upswing; already played out in 2011: We believe positives of fading competitive pressure leading to return of pricing power (i.e. ability to hike tariffs sustainably) has played out over last 5-6 quarters and is already reflected in stock prices. Average rate realisation per minute (ARR) has improved for all three major players (Bharti, Idea, and RCOM) in Q2FY12 driven by tariff hike in June/July 2011, and slow 3G adoption.

Regulatory concerns would fade over 2012: We believe telecom stock performance in 2012 would be driven by resolution of regulatory concerns. Though it appears that all regulatory outcomes may not be positive for incumbents like Bharti and Idea (e.g. excess-spectrum fee, license fee of 8% rather than 6%, scrapping of roaming fee over time, 3G intra-circle roaming agreements, etc) but some favourable outcomes (like spectrum sharing and trading, service resale) may mitigate impact of negative outcomes, and incumbents are in much better position now to effect compensatory tariff hike.

Net debt load may stay elevated till early 2013: Bharti and Idea's net debt load may not start to taper off before 2013 as (1) some of the possible regulatory outcomes in 2012 may entail immediate cash outflow or impact cash generation due to margin dilutive effect, and (2) currency headwind may drive up capex and debt servicing cost marginally.

Outlook: We reiterate positive outlook on telecom stocks under coverage despite rising currency headwinds and persisting regulatory uncertainty, based on (1) Bharti and Idea's ability to gain revenue market share despite weakness in subscriber market share, (2) declining competitive intensity leading to sustainable tariff hikes, and (3) possibility of regulatory clarity from early 2012 starting with final version of New Telecom Policy.

Valuation: Bharti trades at EV/EBITDA of 8.6x FY12E and 6.9x FY13E earnings. We maintain Buy with target price of Rs467 (using 8x FY13E EV/EBITDA) based on (1) possibility of ARR improvement, (2) possible margin expansion over FY13, (3) monetisation of 3G assets, and (4) improving business performance in Africa operations.

Idea trades at P/E of 47.8x FY12E and 25.9x FY13E earnings. We maintain Add rating with target price of Rs100 (using 7.2xFY13E EV/EBITDA, a 10% discount to Bharti to factor in higher regulatory risk) as we believe most of the positives from ARR expansion is already priced in. Since regulatory risk is discounted more in Idea, we believe the stock has potential to outperform peers if regulatory outcomes are more favourable than expected.

Source : Equity Bulls

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