Telecom stocks have been in the doldrums for the past three weeks. Tata-DoCoMo fired the first salvo with its per second billing tariff plan. This was followed by other operators, the latest being Bharti and Reliance Communications which have joined the fray recently. This sent shivers through the market which saw margins, already compressed by the entry of new players, getting further compressed.
The Central Bureau of Investigation’s (CBI) probe into the alleged 2G spectrum allocation scam has also fuelled the selling frenzy. As a fallout of the CBI probe, work on allocation of spectrum to all existing operators has been stopped by the Department of Telecom.
Telcos have also posted disappointing Q2 numbers. The quarter gone by also saw average revenue per user and minutes of usage falling because of the dual SIM phenomena. Subscribers are opting for a second SIM card to benefit from discounts.
In this scenario, a further fall in tariffs will only lead to lower margins and further de-rating. However, Akhil Gupta, Joint MD, Bharti Enterprises, says irrational pricing is not new to the telecom industry.
Even Sanjeev Aga, MD, Idea Cellular, is not too perturbed by the short-term competitive pressures or the correction in the company's share price. He says the aggressive pricing is due to desperation from overcapacity. "Prices will fall further on desperation, overcapacity." Aga feels capacity utilisation, spectrum efficiencies will be key going forward. He does not rule out margin compression for the next few quarters. According to him, only a handful of telecom companies will survive in the long-term. "We expect consolidation in the telecom industry. We expect a game changing event in telecom by June 2010."
What should investors watch out for?
Shubham Majumder of Macquarie Research cites three factors which could lead to further scaling down of earnings per share estimates going forward. "One would be per second billing. The other is mobile number portability. You would start to see pressure coming through on the post-paid segment of the business while profitability remains very high on the international and national long distance roaming. Third would be pressures coming on the text and data side of the business. This tariff action is limited to the prepaid segment which is the Rs 100–200 ARPU bracket. However, when you see action move to the Rs 400–500–800 ARPU customer, then you really need to worry for players like Bharti and Vodafone because they are basically honouring a majority of the high ARPU and high value market."
Sanjay Chawla of Anand Rathi Securities says the market is looking for clarity on what is the impact of the recent tariff cuts on margins and earnings. "We will come to know that only in the December quarter results. Secondly, the market wants to see evidence of tariffs bottoming out."
Raamdeo Agrawal, Director and Co-Founder, Motilal Oswal Securities, expects horrifying numbers and sharp margin erosion from the sector going forward. "More than the revenue, the real stark thing will be the margin erosion. It is largely a fixed cost business and any decline in revenue straight away tells on your margins. The largest company would have an EBITDA of about 20 paise. So, if your revenue falls by 15 paise, then you lose about 60-70% of EBITDA."
How should you trade telecom now?
Investment Analyst R Balakrishnan does not understand why investors are so disappointed. "The war in tariffs has been going on over the last quarter. Every new addition is going to bring down the average revenue per user (ARPU). Now, you are seeing handsets, connections getting doled out free because everybody is chasing the number game so that they can get more spectrum. This is a time when telecom companies are deliberately sacrificing profits for a bigger gain. If you look at it in that perspective and take a view two years down the road, the sector is still very healthy. The licences are still coming very cheap by international standards. So it’s a win-win game for them."
Dipan Mehta, Member, BSE and NSE, and Balakrishnan feel investors should buy telecom on dips and play it for the long-term.
To bolster his recommendation, Mehta states that telecom is a difficult business with volatility in quarterly earnings. "Although there is good long-term visibility, in the short-term there are always issues of project delays and even operating profit margins. There is quite a bit of variance depending upon the stage of completion of the project. It’s a business which is not secular in every quarter. This is a reality which investors have not priced or built into their expectations."
Mehta feels investors should enter at certain levels and price points. "Although the results by and large have been below street expectations, the order book certainly seems to be gathering momentum." Seconding Mehta, Balakrishnan says any sell-off should be used as a buying opportunity.
However, Technical Analyst Mitesh Thacker and Chawla do not share Mehta and Balakrishnan's optimism on the sector. Thacker does not wish to take a contra call. "The long-term charts are extremely weak for the entire sector. Till these stocks don't see some kind of base building happening, I don’t think prices are going to go up quite significantly. This sector remains an avoid as far as long side trading is concerned. I am not comfortable on the short side as it is oversold. Probably, we need to take a step aside, give the stock prices some time to consolidate, and tell you which direction they are ready to move again."
Chawla says the correction is closer to the end now in terms of price damage, but it is the time correction that is likely to be extended. "That may well last for another three-six months. The Telenor launch is around the corner and DoCoMo is still entering new circles. Number portability is also about to come in plus there is the 3G overhang. We don’t see the time correction ending until the Q1 results are out. Until April next year, we don’t see stocks doing much. But we see very limited downside in terms of absolute price correction for stocks from current levels."
Manishi Raychaudhuri, MD and Head-Research, BNP Paribas Securities, is neutral on the sector. “This sector’s fundamentals have been harmed very badly by the competitive intensity. At present, the only stock that we have in our portfolio is Bharti.”
Even Investment Advisor Sharmila Joshi says the growth seen during the hay days is over. "Even if you see growth, it is going to be far more muted. This sector is not going to go any where in the next 5-6 months at least. "
Stock tips:
Vineet Bhatnagar, MD, MF Global, says smaller players like Idea Cellular do look like a good trading bet for a two day trade or for an intraday trade. "One can trade Idea on the long side with a target of about Rs 65."
But Hemang Jani, Senior Vice-President, Sharekhan, says it makes sense to be with the leader at this point of time. "From that context, we would avoid somebody like an Idea and other players. Bharti would be a relatively better bet. From an investment perspective, Bharti looks definitely attractive at 11 times forward price to earnings."
Chawla does not see Bharti's P/E dipping below 12 times. "If we assume that the revenue per minute will bottom out at 45 paisa per minute, then we get a worst case value of Rs 300. But we also like to look at the stock on a price to earnings basis. We don’t see the P/E ratio dipping below 12 times because this is the ratio at which even a company like China Mobile trades. We don’t see Bharti’s P/E ratio de-rating below that of China Mobile."
Even Raychaudhuri rules out further pain in Bharti. He feels Bharti has the advantage as it operates at a very high capacity utilization. “It does not need to get as competitive in terms of price cutting as its primary competitors are. I think the impact on Bharti would be relatively cushioned. At the present valuations, a large part of the negative influence is already discounted.”
Ambareesh Baliga of Karvy Stock Broking too advises investors to buy Bharti. "The worst in Bharti is already there in the price because billing rates cannot fall below one paisa per second. It cannot go into nano seconds."
However, Joshi feels investors need to see how fundamentals pan out before taking a call on the stock. "We really need to wait for another quarter and see how things shape up in this recent price war, which has now got triggered off recently. Do really minutes of usage increase after that and do they really add more subscribers? Three-four months down the line that question will get answered. If an investor is ready to wait 2-3 years, he can hold on to the stock.”
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