Reliance Communications (Q1 FY11) – MP (Target Rs158, Downside 6.0%)

CMP Rs168, Target Rs158, Downside 6.0%

• Q1 revenues flat qoq on below than expected wireless growth at 1.5%
  
  
• Global revenues down ~11% as Q4 FY10 included a one-off high external NLD traffic component from non-Rcom carriers
  
  
• Removal of ~50% of systemic free minutes cause 7.2% fall in MOUs but stable RPMs cushion ARPU decline 
  
  
• Network opex down 14% qoq due to decline in fuel and maintenance cost, supporting a 52bps rise in OPM
  
  
• A Rs12.5bn swing in net interest cost implies 83% fall in PBT; Reported PAT down despite net tax income and lower depreciation (due to one-time impairment charge Rs2bn in Q4)  
  
  
• Company achieves ~24% of our FY11 EBIDTA forecast but even so we cut EPS, rating & TP in view of increased interest cost 

Wireless revenues flat, Global down ~11% due to Q4 one-offs

Rcom Q1 FY11 topline was stagnant qoq on account of flat wireless revenue and one-offs in global segment in Q4. Mobile base jumped 8.2% qoq but removal of ~50% of systemic free minutes caused a 7.2% drop in MOUs, the worst such fall since Q4 FY09. However stable revenue/min restricted the inevitable ARPU decline to 6.5%.

MOU growth lags peers but RPMs largely in line

MOUs, albeit now more profitable/call basis with removal of free minutes, have not displayed the uptick seen at Bharti and Idea in the past two quarters although RPM is now largely in line after lagging for several quarters. Global revenues were down ~11% qoq, worse than estimated, due to presence of high external NLD traffic from non-Rcom carriers in Q4.

Operating profit rose 2% as a decline in network opex due to 1) migration of base stations to state grid from high cost diesel-based electric supply and 2) lower network maintenance cost countered an increase in access charges on account of rise in off-net minutes. Rcom provided Rs250-300mn as provision for higher spectrum cost while SG&A included brand promotion expenses for DTH and bulk payment for the T-20 tournament.  

Net interest cost of Rs4.4bn included ~Rs2bn in notional MTM loss which largely explains a massive ~83% fall in PBT, even though depreciation declined 11% due to one-off impairment hit of Rs2bn taken in Q4 FY10.

Cut EPS estimates on increased interest cost; downgrade to MP

Rcom has achieved ~24% of our annual FY11 revenue/EBIDTA forecast but in light of the reported interest cost in Q1, we cut our FY11/12 earnings estimate by 25%/21%. Our estimates do not factor in the extent of cash infusion (and hence lower debt to that extent) and swap ratio details in GTL-Reliance Infratel deal. On the operational front, Rcom has bridged the RPM gap with Bharti and Idea, but we remain concerned on the lack of traffic growth, now seen at other incumbent telcos.

The stock has outperformed the benchmark Sensex over the past 3 months, albeit by the least of margin compared to that for Bharti and Idea, as pace of ARPU erosion subsided for all the major operators. However, current FY12 valuation of 11.5x PER and 7.3x EV/EBIDTA leave little headroom for further upside, in our view. Downgrade the stock to Market Performer with a revised 9-month TP of Rs158. Monetization of tower arm and stake sale to a strategic partner at significant premium to CMP represent key risks to our rating.