Rostelecom - Good EBITDA Not Yet Converting Into Good FCF

We reiterate our HOLD recommendation for Rostelecom commons and increase our target price by 9% to R101 per share given our revised risk assumptions for Russian equity (a lower risk-free rate and equity premium - 5.5% and 5.0%, respectively), which is partially offset by slightly lowered forecasts (based on the guidance). On our estimates, the stock is trading at a 2021E EV/EBITDA of 3.4 and P/E of 8.4. We expect dividends of R5.0 per common share over a 12-month horizon (implying a 5.4% yield). > 2Q20 above consensus; good EBITDA, but negative FCF. Revenues grew 13% y-o-y in 2Q20, supported by solid growth in mobile (16%) and digital services (68%), the EBITDA margin rose 0.8 pp y-o-y to 38.3%. However, operating cash flow was offset by increased accounts receivable and FCF came in at negative R8.8 bln (down from positive R14.6 bln in 2Q19), also affected by a 25% y-o-y increase in capex to R27.6 bln including government programs (and 35% growth excluding them), which owed to the uneven distribution of capex over the year. Net debt/LTM EBITDA edged up from 2.0 to 2.2.> Guidance conservative. Given the persisting uncertainty, the company expects both revenues and EBITDA to rise by "at least 5%" this year, which is rather conservative and at the low end implies respective 0.7% and 3.5% y-o-y declines in 2H20. It would also mean a significant slowdown from the 11% and 14% y-o-y growth in 1H20. Still, the updated guidance is well below the 7.6% revenue and 8.8% EBITDA growth we now expect for 2020.> Capex. The guidance for capex excluding state projects of R100-110 bln was in line with what the company had guided (R70-75 bln excluding Tele2, plus capex for Tele2 comparable to the 2019 level of around R33.8 bln). We now see capex this year at R102.3 bln, which is 20% of our revenue estimate.> Valuation. We reiterate our HOLD recommendation for Rostelecom commons and increase our target price by 9% to R101 per share given our revised risk assumptions for Russian equity (a lower risk-free rate and equity premium of 5.5% and 5.0%, respectively), which is partially offset by lowered forecasts (based on the guidance). On our estimates, based on EV/EBITDA for 2021E, Rostelecom trades at a discount to MTS locals and a premium to VEON (3.4 versus 4.9 and 3.1, respectively), though compared with MTS it is far less liquid ($3.9 mln traded per day versus $56.9 mln for MTS) and has a lower dividend yield (5.4% for Rostelecom versus 8.7% for MTS).> Things to watch. The things to look out for are an updated strategy (which should include plans for the Tele2 consolidation and is due by year-end), and a recovery in FCF.