1. Underweight rating on Reliance Communications: Weighed down with debt, rivalry

Underweight rating on Reliance Communications: Weighed down with debt, rivalry

Reliance Communications reported an in-line quarter with modest improvement in India revenue growth, healthy Ebitda margins, continued reluctance to invest and uncomfortably high leverage.

By: | Updated: June 8, 2015 1:23 PM
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Reduction in debt remains the most important ‘to do’ for RCom. (Photo: Reuters)

Reliance Communications reported an in-line quarter with modest improvement in India revenue growth, healthy Ebitda margins, continued reluctance to invest and uncomfortably high leverage. RCom’s India revenues grew about 5.5% y-o-y (marking the first quarter of 5%+ y-o-y growth in the last six quarters) – much below Idea (19.5% y-o-y) and Bharti Airtel’s (11.0% y-o-y) wireless revenue growth.

Mixed voice metrics with improvement in minutes growth and ARPUs, but both voice and blended ARPM (average revenue per user/minute) decreased sequentially. RCom reported healthy data traffic growth, but it did not translate into data revenue growth due to low data realised rates.

RCom remains reluctant to invest in its network and service quality,y as the company guided for FY16 capex of R15-20 bn i.e., 6-9% of revenues (vs. mid-to-high teen % for peers). The number of 2G/ 3G sites remain unchanged for eight-nine quarters. Debt levels remain uncomfortably high. The high financial leverage will limit RCom’s ability to invest in network & customer service, causing further market share erosion.

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Despite continued market share loss, RCom’s valuation multiple (EV/FY17e Ebitda) of 6.3x remains the highest in the sector. Hence, we retain our UW (underweight) rating on the stock.

Mixed operating metrics in India business. RCom’s Q4FY15 minutes growth of 5.7% is broadly comparable to Bharti & Vodafone’s minutes growth driven by significant increase in MoUs (minutes of usage), but after several quarters of anemic minutes growth. RCom reported 11.5% y-o-y increase in MoUs & 14.8% y-o-y increase in blended ARPU primarily due to improvement in quality of subscribers (in our view) as the company had been culling the low-quality subs for several quarters.

India Ebitda margins are modestly below Bharti’s margins and ahead of Idea’s standalone margins despite revenue market share (RMS) of just above 6% vs. Bharti & Idea’s RMS of about 31% and 18%, respectively. We see downside risk to RCom’s margins.

Takeaways from Q4 results and the conference call

RCom’s India revenue growth is driven by both voice and non-voice segments. The improvement in revenue growth might be due to revenue contribution from RJio. RCom’s India voice revenues grew 2.2% q-o-q and about 6.3% y-o-y in Q4FY15. Non-voice revenues grew 4.5% q-o-q and 16.5% y-o-y despite healthy data volume growth, which is muted, relative to peers. Notably, RCom’s non-voice India revenues include data revenues. Data traffic on RCom’s network rose 14.1% q-o-q and 73.6% y-o-y. The weak non-voice revenue growth points to meaningful decline in data realisations.

Interestingly, RCom’s non-voice India revenues of R12.1 bn is lower than Idea’s data revenues of R14.2 bn despite the fact that total data traffic on Idea’s network is about 54.5 bn MB, which is just 63% of total data traffic on RCom’s network (about 87.2 bn MB).Notably, the Others India business saw revenue decline of 16.2% q-o-q (55% y-o-y) in Q4. Others business primarily includes internet data centres and direct-to-home business.

To put RCom’s revenue in perspective, Idea reported 19.5% y-o-y revenue growth its wireless business in Mar-15 quarter – more than thrice RCom’s y-o-y India revenue growth. Bharti Airtel reported 11% y-o-y revenue growth. Hence, RCom continues to lose market share to rivals, in our view.

Interestingly, RCom’s India revenues do include some revenues from optic-fibre sharing and tower sharing deals with Reliance Jio.

Surprisingly, Global operations revenues increased 2.6% y-o-y (and 4.7% q-o-q) driven by solid y-o-y voice revenue growth. Global Operations delivered double-digit (13%+) y-o-y growth in Dec-14 quarter, but this segment registered y-o-y revenue decline for five straight quarters before that. Hence, the growth over the last two quarters might not indicate a trend.

Leverage continues to be high. Net debt-to-Ebitda ratio at 4.6x remains high. Also, we think the reported debt of $5.9 bn does not include the spectrum liability from Mar-15 auction–including which net-debt-to-Ebitda will be 5x+. RCom is unable to reduce leverage despite healthy FCF (free cash flow) generation. We think reduction in debt remains the most important ‘to do’ for RCom.

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