VEON - Target Price Cut, But Upgraded to BUY After Recent Performance

We reduce our VEON target price by 37% to $1.92 per share. This was mainly driven by macro factors and the Russian operations. However, as the share price has halved from pre-4Q19-results level, which is not justified by the fundamentals, we upgrade the stock to a BUY. We think that VEON might not have enough FCF after frequency payments to pay dividends in 2020 given that it guided an increase in operating capex. We see the key challenges for VEON as turning around its operations in Russia, re-establishing a positive dialogue with the regulator in Pakistan, returning to consistent FCF generation and maintaining dividend payments.> Russian operations in need of turnaround. Russian mobile service revenues fell 5.9% y-o-y in ruble terms in 4Q19, while Russian mobile subscribers dropped 1.1%. EBITDA in Russia on an LFL basis fell 1.6%, for a 33.4% margin (up 0.6 pp). The CEO of the Russian operations stepped down in June. Russia is the most problematic area for the company. VEON is losing market share to Tele2, so it will be important to look out for who is nominated to take over the Russian division. Operators in Russia will benefit in 2020 from the market-wide repricing of tariffs early this year (including VEON's) and downsizing of loss-making retail operations. Both VEON and MTS have reduced their store counts by 200 y-o-y, and VEON expects to close around 600 stores over the next couple of months. The delay of the 5G launch in Russia will smooth out the pressure on FCF. > Valuation. We reduce our VEON target price by 37% to $1.92 per share, due mainly to the Russian operations and macro factors. However, given that the share price has halved from pre-4Q19-results levels, which is not justified by the fundamentals, we upgrade the stock to BUY. We think that VEON might not have enough FCF after frequency payments (assuming that it will have to pay $450 mln to renew its Pakistan licenses) to pay dividends in 2020 given the guided increase in operating capex (by around 1 pp as a percentage of revenues; we see it flat y-o-y in dollar terms). VEON is trading at a 3.2 2020E EV/EBITDA and 5.5 PE. We expect its EBITDA in dollar terms to grow at a 0% CAGR over 2019-22E, with a 5.3% y-o-y drop in 2020 due to currency depreciation and a weak performance in Russia. We expect equity free cash flow net of frequency payments and excluding a one-off payment from Ericsson in 2019 to grow at a 3.7% CAGR. Net debt/EBITDA was 2.1 as of end-2019. Net debt was 47% in rubles, which is close to the share of ruble EBITDA.> Risks and concerns. These include economic uncertainty, local currency weakness, an inability to upstream cash (including in Pakistan), regulatory pressure, competition from Tele2 in Russia, the cost and availability of frequency licenses, and whether the new management will be able to turn around the Russian operations.