Telecom overhang to stay

Aug 25 2014, 01:36 IST
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SummaryValuations expensive, with no near-term triggers

RIL

Rating: Equal Weight

RILís $12-bn spend to launch its telecom business could lower its ROCE (return on capital employed) 400 bps and profits 5% by FY17. Downstream expansion may enhance profits by 64% by FY17e, but this is back-ended. We downgrade to EW (Equal Weight) on expensive valuations and lack of near-term triggers except for gas price hike.

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Telecom business in India is good, but comes at a cost: Our case study of Indiaís wireless market suggests revenues to grow from $29 bn in FY14 to $44 bn by FY18 driven by data contribution doubling to 23%. High ARPU (average revenue per user) and data to be target market for R Jio. Capex spend by R Jio to-date has been an aggressive $8.8 bn, with almost half of this spent on spectrum. Our analysis indicates it could take three years to achieve Ebitda breakeven and five years to reach profitability. In the interim, RILís ROCE will be lowered by its telecom business.

We are not constructive on refining and petchem cycles currently. Refining is saddled with incremental capacity, especially from the Middle East. Petchem has seen negative demand growth in China YTD (year-to-date) as against growth expectations of 6-7%, leading to softer netbacks.

RIL trades at 9.8x FY15e EV/Ebitda (enterprise value/ earnings before interest taxes depreciation and amortisation), which is 14% higher than its historical average and >30% premium to its global peers, making valuations unattractive. Why not UW? Though FII holding is high at 23%, the stock has underperformed Sensex by 8% YTD, 30% in four years, and under-ownership is 243 bps. Downstream expansion, gas price hike, and increased contribution from shale should increase Ebitda by 75% by FY17e, giving a healthy earnings CAGR (compound annual growth rate) of 15% over FY14-17e.

óMorgan Stanley

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