Margin pressures, revenue worries may hit Tata Communications' prospects

Operating profit margins of TATA communications fell by 135 basis points to 24.5% due to a jump in costs, which were back-ended

A muted near-term outlook, a double-digit cut in earnings growth estimates after a weak operating performance in the March quarter (Q4FY22) weighed on the stock of Tata Communications. It was down about 14 per cent since Tata Communications results last Thursday evening.

While the company’s consolidated revenue performance was in line with the street’s expectations, rising 1.9 per cent on a sequential basis, its operating profit disappointed falling 3.4 per cent. This was the second consecutive quarter of decline and the figure came 6-9 per cent lower than what analysts were working with.

Operating profit margins fell by 135 basis points to 24.5 per cent due to a jump in costs, which were back-ended. The company indicated the FY23 margins would be closer to the lower end of the 23-25 per cent range due to higher employee costs and travel expenses. The company is increasing its capital expenditure to $300-$325 million from $220 million in FY22, as it seeks to boost its subsea cable network. 

While analysts at Motilal Oswal Research believe that there are improvement levers in margins by 300-400 basis points and 10 per cent gains from the recovery in loss-making businesses, they highlight that the management aims to invest in growth. It has guided at margins in the 23-25 per cent range as compared to 25.3 per cent in FY22, underscoring the limited possibility of further margin-led earnings growth, they add.

Revenue growth was led by the data segment (77 per cent of revenues), which was up 2.1 per cent. Within the data segment, digital platforms and services outperformed with sequential growth of 3.4 per cent. Emkay Research believes that for any valuation re-rating sustained double-digit revenue growth in the digital segment is essential.  

However, core connectivity solutions, which forms 69 per cent (of the data segment), was flattish (0.7 per cent growth) on a sequential basis. The company expects growth in this segment to improve as the back-to-office trend gathers pace and demand for connectivity solutions rise. The voice business continues to decline and now accounts for 13.7 per cent of revenues in FY22 down from 20 per cent in FY20. 

Improving cash flows and falling debt, however, are positives for the company. Free cash flows were strong at Rs 2,620 crore for FY22 enabling the company to bring down its net debt by Rs 450 crore to about Rs 6,700 crore; net debt to operating profit has come down to 1.61 times (q-o-q) now as compared to 1.7 times. 

Overall, brokerages have cut the operating and net profit estimates due to the muted near-term outlook. Says Balaji Subramanian of IIFL Research, “The company continues to witness modest revenue growth due to macro factors (delays in deal closures, chip shortage) and company-specific issues (employee attrition, execution challenges). A combination of lower revenue and higher cost drives a 12 per cent cut in operating profit for the next two years. The net profit (estimates) cut at 24-26 per cent is higher than the cut at the operating level due to higher capex.”

While the stock has corrected, given the near-term sales growth uncertainty, investors should await improvement in the revenue and margin trajectory.