Q2FY24 Review: Tata Communications: Margins to worsen before they get better

23 Oct 2023 , 12:06 PM

TCOM had a weak Q2 with Digital Portfolio revenue declining 1.2% QoQ (organic) and Ebitda margin declining QoQ and YoY, along with a rise in net debt. On the earnings call, management was cautiously optimistic and attributed the recent delay in the conversion of pipeline into orders to macro factors. With Kaleyra getting consolidated from Q3, both Ebitda margin and ROCE will dip below 20% in the near term. The medium-term margin target of 23-25% stays. While analysts of IIFL Capital Services maintain Ebitda est., FY24/25/26 EPS sees 15%/6%/2% cut on higher D&A and interest. While investors cheered TCOM’s revenue growth acceleration in the recent quarters and its inorganic moves, there could be a near-term revenue speed bump due to macro weakness. Analysts of IIFL Capital Services believe that achievement of the 23-25% medium-term target is not devoid of risks, owing to potential integration challenges of Kaleyra (which made a small Ebitda loss in CY22). At 12x, TCOM’s 1YF EV/Ebitda is >1SD above mean. Their SoTP-based Dec’24 TP comes to Rs1,675. Maintain REDUCE. 

Weak Q2 on most counts: 

Organic revenue growth of the Digital Portfolio business was -1.2%/+16% QoQ/YoY, suggesting significant sequential deceleration. Overall Ebitda declined 1%/10% QoQ/YoY. Net debt-to-Ebitda rose from 1.44x to 1.67x QoQ on dividend payout, higher capex and WC deterioration. With Kaleyra acquisition completed subsequently on 5th Oct, analysts of IIFL Capital Services expect the leverage ratio to rise to 2.25x. We also note: 1) Increase in Kaleyra’s net debt to US$187mn from US$150mn at the time of the deal announcement. 2) Increase in contingent liability pertaining to the AGR case from Rs65bn to Rs77bn. 

Cautiously optimistic mgmt commentary: 

Key takeaways from the earnings call: 1) There is some slowness in decision making due to weak macro factors, though the recent salesforce augmentation should improve TCOM’s deal win rate. 2) Ebitda margin will be a function of organic portfolio mix (a structural drag), M&A (initially a drag but should subsequently reverse), and operating leverage (a tailwind). 

Maintaining Ebitda, but pruning EPS: 

There is no change to Ebitda estimates that analysts of IIFL Capital Services had cut in their Q2 preview note, considering the macro challenges and near-term margin dilution from Kaleyra. Higher D&A and interest expense lead to 15%/6%/2% EPS cut for FY24/25/26.