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MOSL: TATA COMMUNICATIONS (Neutral)-Growth in emerging segments elusive- Data growth run-rate to moderate

TATA COMMUNICATIONS: Growth in emerging segments elusive; Data growth run-rate to moderate

(TCOM IN, Mkt Cap USD2b, CMP INR465, TP INR525, 13% Upside, Neutral)

 

• Traditional impresses but other segments subdued: Performance was steady in the first quarter of the year, with consol. EBITDA growth of 10% QoQ to INR7.6b (20% beat) on a pre-Ind-AS 116 basis (at INR8.3b on post-Ind-AS 116 basis). Traditional segment (part of Data) impressed, with sequential EBITDA growth of 15% and margin improvement of 490bp (36.2% v/s management guidance of ~30%). As a result, Data EBITDA grew 19% QoQ to INR6.7b. However, the quarter was also characterized by the dismal performances of the small but promising segments of Growth (EBITDA down 50% QoQ), Innovation (loss of INR1.4b) and Transformation (-24% QoQ).
• Concall highlights: (1) Traditional EBITDA margin is expected to stabilize at 32% on a pre-Ind-AS 116 basis v/s 36.2% in 1QFY20 (33-34% on post Ind-AS 116 basis). (2) Transformation margin was at 6.2% due to upfront investments, but profitability is likely to improve in 2HFY20. (3) Growth segment won large deals, which hurt margins. However, the situation is likely to improve gradually. (4) FY20 capex guided at ~INR200m v/s INR250-300m in the previous fiscal.
• Prolonged low profitability in emerging segments: The small and emerging segments like Growth, Innovation and Transformation witnessed little improvement, with growth expected to slow down even further. Although Traditional margin exceeded our estimate, it is likely to trace back and stabilize at ~32%. As a result, we now lower our segmental margin and EBITDA estimates for the coming quarters. Our pre-Ind-AS 116-based consol. EBITDA CAGR estimate (FY19-21) remains unchanged at 13%.
• Valuation and view: We value TCOM on an SOTP-based target price of INR525 (v/s INR600 earlier), ascribing 6.5x/3x on FY21E data/voice EBITDA (ex-INR176 to the land bank), and maintain our Neutral stance. Prolonged investments and uncertain growth trajectory in Innovation, Growth and Innovation are a cause for concern and could potentially restrict further upside in the stock price.