Friday, June 1, 2012

>RELIANCE COMMUNICATIONS: Margins decline due to higher network operating costs

Wireless revenues were below our estimates, led by a sequential fall in the ARPU. However, overall revenues grew 5% owing to healthy growth in the Global Enterprise and Others segments. Higher network operating costs drove a 67% q‐o‐q fall in the PBT. Negative tax provisioning and minority interest, however, saved the day, helping the PAT rise 78% q‐o‐q to INR3.3bn. On the other hand, write‐offs due to bad debts and forex variations led to an INR32bn decline in the net worth. We lower our earnings forecasts up to 12% over FY13f–FY14f. Reduce TP to INR59, including the impact of likely refarming, license & spectrum renewal fees and free roaming. Upgrade the stock to Hold due to a c24% underperformance in the last three months. 

■ Wireless segment disappoints; consolidated revenues up 5% q‐o‐q The 1.3% sequential growth in wireless revenues was below expectations due to a q‐o‐q fall in the average revenue per minute (ARPM). The significant q‐o‐q drop in the ARPM after seven quarters has not led to strong growth in total minutes. Consolidated revenue grew by 5% q‐o‐q led by 4% revenue growth in Global Enterprise and 18% in Others. We expect a slower revenue growth of 9% during FY13f–FY15f. 

■ Margins decline due to higher network operating costs As a percentage of sales, the network operating costs rose 500‐bp q‐o‐q. This was partially offset by a 180‐bp q‐o‐q decline in SG&A costs, as a percentage of sales. Though the management attributed this increase to be a seasonal phenomenon, the network operating costs, as a percentage of sales, rose 600‐ bp y‐o‐y in FY12. We expect a 307‐bp improvement in the EBITDA margin over FY13f–FY15f. 

 PAT higher on one‐offs; net worth fell by INR32bn PAT was up 78% q‐o‐q to INR3.3bn led by one‐offs. This includes a negative tax provision of INR1.2bn on the reversal of provisions, which are no longer required. Also, the provision for losses worth INR1.3bn towards minority interest on restructuring of a foreign subsidiary boosted the PAT. However, the consolidated net worth declined INR32bn during the quarter (INR16/share) owing to various write‐offs, including INR11bn worth of debts due from cancelled licensees. Other write‐offs are mainly due to forex variations. 

■ Downgrade earnings; include regulatory impact; upgrade to Hold We reduce our PAT estimates up to 12% over FY13f–FY14f to reflect a moderation in our growth assumptions for the wireless segment. Furthermore, we include a regulatory impact of INR7/share for refarming, INR2/share for license renewals and INR3/share for free roaming in the new proposed telecom policy. Thus, we arrive at a Jun13 TP of INR59. Due to a c24% underperformance over the last three months, we upgrade the stock to Hold. At our TP, the stock is likely to trade at one‐year forward EV/EBITDA and P/E multiples of 4.3x and 6.0x, respectively. The success of the planned IPO of the subsea telecommunications infrastructure business is a key upward risk to our call.