Idea Cellular faces an uphill climb

Fills spectrum gap in key markets; Q2 disappoints; likely price wars could hurt financials

The stock of Idea Cellular, which had seen some gains after 53-month intra-day low of Rs 71.25 last week, was down 3.8 per cent (at Rs 77) on Monday, before its September quarter (Q2) results after market hours. Although Q2 is seasonally weak, results were below expectations. Voice minutes fell and rates in mobile voice and data segment were under pressure. As a result, consolidated operating profit fell 7.6 per cent to Rs 2,840 crore and operating profit margin dipped 187 basis points to 30.5 per cent sequentially in Q2FY17, lower than expectations of Rs 2,990 crore and 32 per cent, respectively. Net profit at Rs 91.5 crore was also lower than Rs 193.7-crore Bloomberg consensus estimate.

Stock could see further pressure on Tuesday.

Beyond results, Street is concerned that India's third-largest cellular operator will find it tough as it has to spend considerably to match its larger peers on network, take a profit hit given pricing pressures and deal with a sharp increase in debt.

Idea has raised its capital expenditure (capex) forecast from Rs 6,500-7,000 crore to Rs 7,500-8,000 crore for FY17 (compared to Rs 7,769 crore for FY16). During FY12-16, it had spent Rs 14,600 crore. The investments in spectrum in recent auction of Rs 12,800 crore (upfront payment Rs 6,400 crore) will worsen debt. Coupled with network rollout, net debt will increase from Rs 36,400 crore to Rs 55,000 crore, say analysts. Net debt to operating profit is expected to move from 3.25 times at the end of FY16 to over four times after the auctions, they add.

Idea has indicated that its capex outlay is enough to meet core rollout requirements and that peak capex will be behind in FY18. While Idea had a cash profit of Rs 10,120 crore in FY16 (Rs 4,462 crore in H1FY17) and it is confident of taking care of its debt, it reported a negative free cash flow for FY16 if capex and spectrum payout are included, says India Ratings. Bharti Airtel's positive free cash flow in FY16 was largely supported by sale of tower assets and investments, they add. Idea management has indicated they would be looking at monetising tower assets.

The biggest risk is new telecom player Reliance Jio and its attractive data plans. If the data war intensifies, Idea could witness further erosion in data realisations and profits.

Idea has fortified its spectrum position in recent auctions by filling the gaps in its 4G network in Gujarat, Madhya Pradesh, and Uttar Pradesh (west), but given its focus on smaller towns and not big cities, it needs to be seen how well it holds on to its market share as subscribers in these towns are more price-sensitive.