Idea Cellular improving margins

While the company has outperformed the sector on operational parameters over the past few quarters, regulatory concerns are the key overhang

With most telecom companies cutting down on dealer commissions and initiating selective price rises, a bit of discipline is returning to the sector, helping companies curb selling and marketing expenses and improve margins.

The result of these steps, to some extent, is reflected in the quarterly results of India’s third-largest company by subscribers, Idea Cellular. For the quarter ended September, the company’s earnings before interest, taxes, depreciation and amortisation (Ebitda) margins on a standalone basis were up 32 basis points to 23.6 per cent on the back of a 210- basis points drop in selling and marketing expenses.

These marketing costs, between 15 and 17 per cent of revenues over the last four quarters, fell to 13 per cent in the September quarter as telecom companies looked at ways to curb high, volume-driven subscriber acquisition costs and survive in a hyper-competitive sector.
 

IMPROVING MARGINS
In Rs crore	FY12	FY13E	FY14E
Revenue	19,541	22,442	25,672
% change y-o-y	26.0	14.8	14.4
Ebitda	5,092	6,044	7,484
% change y-o-y	34.3	18.7	23.8
Net profit	722	1,100	1,996
% change y-o-y	-19.6	52.4	81.5
P/E (x)	37.6	24.7	13.6
E: Estimates                                     Source: Kotak Institutional Equities

Kotak Institutional Equities Research analysts Rohit Chordia and Shyam M, while saying that several players had made concerted efforts to control channel cost leakage due to aggressive push for net adds, the extent of benefit has been a positive surprise. However, a continuation of the same will require players to stick to the pricing discipline with respect to not only dealer commissions but also on call charges. And, if the trend sustains, it will not only help the company improve on its performance, but its stock to outperform peers, as has been the case in 2012.

While the short-term regulatory hurdles will remain an overhang, analysts are positive on the Idea stock, which was up a tad on industry consolidation and improvement on operational parameters. At the current price of Rs 82, the stock, which was up one per cent on Tuesday, is trading at 13.6 times its FY14 estimates.

Less talk…
Voice traffic fell four per cent quarter-on-quarter. While the quarter is considered a seasonally weak one, Kotak analysts say the weakness could be due to Bharti’s aggression and the impact of intensified focus on controlling channel costs. Lower volumes meant the company’s revenues and operating profit were lower by three per cent and one per cent, respectively on a sequential basis. This also reflected on its operating metrics—minutes of usage and average revenue per user both falling five per cent quarter-on-quarter.

Deutsche Bank analysts, too, believe voice revenue growth, which were growing 20 per cent year-on-year over the last few quarters have moderated to about 11 per cent in the September quarter due to competitive pressures from Bharti.

…more data usage
Despite the lower volumes which reflected in the one per cent fall in voice revenue per minute, average revenues per minute were up due to higher data/value-added services (VAS) usage, which jumped eight per cent. Data revenues as a percentage of sales grew 110 basis points to 15.6 per cent and Morgan Stanley analysts expect the number could grow to 17 per cent of revenues by FY14. This bodes well as VAS typically add to the margin as compared to plain vanilla voice services.

Hurdles remain
The company continues to spew out spare cash. It was free-cash flow positive in the quarter as cash profits at Rs 1,100 crore were higher than the capex of Rs 950 crore. However, given the regulatory overhang, Deutsche analysts say over the next three years the company will have to shell out excess spectrum and licence renewal charges to the tune of $4.3-$4.6 billion compared to the free cash flow of $900 million. However, Idea will not be alone and many telcos will see a similar trend.