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Tata Communications' Q4FY18 results (Neutral) - Formal roadmap to FY21 adds more accountability

Q4FY18 result highlights

• Q4 operating performance below par: Revenue was down 2.4% qoq to Rs41bn (voice -14.2%; data +1.6% qoq in INR terms; IDFCe Rs42.5bn); EBITDA at Rs6.12bn beat estimates (IDFCe. Rs5.6bn).Margins at 14.9% improved 150bps qoq (GDS +210bps to 18.7%; GVS at 6%). Net profit of Rs100m missed estimates on higher tax rates which included impact of Rs160mn on account of change in US tax.
• Formal margin roadmap for FY21: The management in its analyst meet laid out the roadmap and expects data margins to expand to 23-25% by FY21. This will be led by 5-6% improvement in revenue productivity (scaling of growth and innovation services) and 1-2% from cost productivity. Historically we have seen TCOM slip on the margin execution but this formal outlook does add more accountablity .
• Tata sons reaffirms commitment to enterprise business: Mr.Saurabh Agrawal, CFO Tata Sons attended the analyst meet and reaffirmed their commitment to the enterprise business and TCOM. Additionally Tata Sons will be willing to support TCOM with equity capital if and when needed. We do think that TCOM would need equity support eventually, should they decide to buy TTSL’s enterprise business.
• TTSL Enterprise – a risky capital allocation decision : TCOM’s decision to purse acquisition (not announced yet) of the TTSL SME enterprise business, is a capital allocation decision we are little convinced about for the following reasons 1) Doesn’t materially strengthen its growth service portfolio, 2) we see limited demand of new gen services by India SMB customers , 3) likely to be a big increase in capital employed for TCOM(depending on valuations of TTSL-Enterprise) and increase leverage ratios substantially,  and 5) impending entry of Jio in India SMB enterprise business.

Key positives: Traction in Growth services and margins in traditional data

Key negatives: Continued losses in Growth services

Impact on financials: FY19E/FY20 EBITDA changed by -1.7%/+0.7%.

Valuations & view

We have liked the TCOM emerging service portfolio; however weak execution has led to continued disappointment on EBITDA and weak ROCEs. Although a formal margin target FY21 pushes for more accountability, our estimates already factor in margin recovery. Further we think with TTSL enterprise business acquisition, the capital employed will jump and could be a drag on ROCEs. Valuations remain cheap and we would like to see more stable margin delivery and growth to get more constructive on the name. Maintain Neutral with unchanged target price of Rs655.