Tata Communications needs to grow digital portfolio faster to meet targets

Weak Q2 show that led to recent weakness in stock price likely to weigh on near-term outlook

The stock of Tata Communications has shed 16.3 per cent since the start of October. Weak operating performance in the September quarter and lower margin expectations that led to the recent weakness in the stock price are expected to weigh on its near-term outlook. The Q2 showing led to cuts in profit estimates and assumptions that the recovery in margins would be gradual. 

  Overall revenues of the company grew 18 per cent over the year-ago quarter and a sedate 2 per cent on a sequential basis. Growth was boosted by Rs 86.5 crore of other operating income relating to reversals from the prior period. 

  The revenue uptick was led by the data segment, which accounts for 84 per cent of revenues and was up 3 per cent on a sequential basis. Within data, the core connectivity segment grew 2.5 per cent while the digital portfolio saw a 4 per cent sequential growth.

  The digital segment sales were lower than estimates as higher growth in the incubation business (58 per cent) was offset by weakness in Cloud services which was down 1 per cent and the media which slipped 8 per cent.

  IIFL Research believes that though the digital portfolio revenue is showing signs of acceleration and grew by a healthy 3.6 per cent, it is well below the 29 per cent annual growth required to achieve the Rs 17,000 crore management target by FY27. The disappointment for the company was the 0.6 per cent fall in operating profit on account of lower-than-expected growth in the higher-margin core connectivity segment. The operating profit margin fell 60 basis points Q-o-Q to 19.4 per cent on account of higher network cost (up 4.2 per cent) and employee cost (up 4.7 per cent). This was partly offset by lower other expenses (down 1.1 per cent).

 

  The company aims to maintain an operating profit margin of 20 per cent in the near term while the same remains 23-25 per cent over the medium term. The focus remains on realising the cost synergies from the merger with Kaleyra. 

Analysts led by Aditya Bansal of Motilal Oswal Research have reduced their FY26 operating profit by 3-4 per cent, given the lower margin assumptions by 90 basis points. This is on account of a slower ramp-up in profitability in the digital portfolio. With the rising share of inherently lower-margin businesses in the company’s sales mix, the brokerage believes that margin expansion to 23-25 per cent by FY27 would be difficult. The brokerage has a target price of Rs 1,790 per share. 

 

Balaji Subramanian and Siddharth Zabak of IIFL Research have also trimmed the operating profit of the company by 1-5 per cent on lower revenue and a more gradual margin recovery profile. While Tata Communications has strong capabilities, digital portfolio revenue growth needs to see a meaningful acceleration for re-rating, say the analysts. The brokerage has cut its target price 

from Rs 2,142 to Rs 2,066 a share. 

  Centrum Research expects the revenue contribution from voice business (at 7.4 per cent) to fall further. The rising mix of digital data revenue would continue to drive overall revenue growth with the operating profit margin expected to increase to 23 per cent by FY27, says the brokerage. It has a ‘reduce’ rating on the stock with a target price of Rs 1,858 a share.