TATA COMMUNICATIONS: Soft growth led to margin dilution

(TCOM IN, Mkt Cap USD4.3b, CMP INR1226, TP INR1200, 2% Downside, Neutral)

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– In 4QFY23, TCOM experienced a 4% QoQ decrease in EBITDA (8% miss), while the revenue grew by a modest 1%. This decline in EBITDA is mainly attributed to heavy operational expenditure, leading to a weak data EBITDA margin. But FCF yield remained steady at 7% with a healthy ROCE of 28%.

– With the management underscoring that the growth-oriented opex investments will continue in the near term, we have trimmed our consolidated EBITDA estimate by 5%, building revenue/EBITDA CAGR of 12%/10% over FY23-25E. While growth in data business remains soft, healthy FCF generation and continued deleveraging provide a silver lining, aiding valuations. We reiterate our Neutral rating on the stock.

EBITDA declined 4% QoQ; FCF and dividend yield remain healthy

– Consolidated revenue grew 1% QoQ to INR 45.7b (in line), led by 2% QoQ improvement in data segment. While revenue from the voice segment witnessed a 9% QoQ decline, ‘other revenue’ grew by 1% over the quarter.

– EBITDA declined 4% QoQ to INR 10.3b (8% miss), led by a 7% QoQ decline in data segment EBITDA. This subsequently resulted in a 120 bp QoQ decline in consolidated EBITDA margin to 22.6% (150bp miss), slightly lower than the company guidance of 23-25%.

– PAT after minority declined 17% QoQ to INR 3.3b (in-line), supported by less effective tax and increase in ‘other income’.

– Revenue/ EBITDA/ PAT grew 7%/2%/23% YoY in FY23.

– Annual committed capex increased to INR16.9b from INR16.1b in FY22. FCF increased 16% YoY to INR25.4b in FY23 from INR21.8b in FY22, due to a 10% YoY reduction in cash capex (unlike the company guidance of increase in capex) and 5% increase in OCF.

– Net Debt/ Gross Debt declined INR10.3b/INR9b YoY to INR 57.1b/ INR 75.3b. The company reported an RoCE of 28.3% in FY23 v/s 25.4% in FY22.

Key takeaways from the management interaction

– The company is focused on achieving double-digit revenue growth, which may result in margins falling at the lower end of the EBITDA guidance (i.e. 23%) in FY24. The company plans to maintain its opex and capex investments to achieve their growth targets.

– The capex forecast remains in the range of USD 250–300m (excluding fibre replacement cost). Despite maintaining a 25% RoCE, FY24 may require additional investments, particularly in DPS.

– The company plans to focus on having a 50:50 split between digital services and core connectivity.

– Funnel additions were the best in FY23, due to a considerable increase in major agreements (which are above USD 1mn). The Digital platform and solutions account for 40% of the order book. The business has not seen any retreat from the fragile global macro IT environment.

Valuation and view

– We have reduced our consolidated EBITDA estimate and building revenue/EBITDA CAGR of 12%/10% over FY23-25E.

– The data segment reported a YoY revenue growth of 10% and the management has reiterated improved funnel of new deal. However, the crucial factor for TCOM to achieve double-digit earnings growth will be the effective conversion of these deals into meaningful growth.

– In FY23, the committed and cash capex has been less than the management guidance of USD 250-300 million, which may limit future FCF growth. Nonetheless, it might still generate a healthy ROCE of over 20% and an FCF yield in mid-single digits. The reduction in leverage could be a silver lining, driving PAT growth.

– We reiterate our Neutral rating with a TP of INR1,200 (assigned 8x/3x EBITDA to the Data/Voice business). Consistent improvement in earnings growth visibility will be vital for valuation rerating.

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