Tata Communications: Ongoing supply-side headwinds to hurt near term

The April-June quarter (Q1 of FY23) performance of Tata Communications (Tata Comm) was a mixed bag with operating profit margins better than estimates but revenues missed Street expectations.
 

The operating performance of the data segment continues to disappoint and it was reflected in the stock prices, which fell 1.8 per cent.
 

This comes even as the benchmarks and the broader indices were up over 0.5 per cent.
 

Overall revenues were marginally higher on a sequential basis at Rs 4,310 crore.
 

Growth was led by the voice segment whose revenues were up 4.5 per cent while data segment sales improved by 1 per cent.
 

Growth in the data segment, which accounts for 77 per cent of the overall revenues, has come down from the previous quarter.

Q4 revenues in the segment were up 6.3 per cent.
 

The company indicated that the order book remains strong and grew by double digits over the year-ago quarter while the new order pipeline remains healthy. This, however, is yet to reflect on the data segment revenues, which are in the Rs 3,100-3,300-crore mark for multiple quarters now.
 

Analysts led by Aliasgar Shakir of Motilal Oswal Research said, “The management’s commentary on deal wins and funnel growth has been buoyant. However, revenue from data, which is a major contributor to the overall revenue, has seen muted growth in the last few quarters.”

The management highlighted that it had achieved a profitable data revenue growth despite ongoing supply-side headwinds.
 

Also, original equipment manufacturer (OEM) lead time issues, which had worsened during the April-June quarter, rose four times as compared to the earlier 12-16 weeks.
 

Brokerages expect the issues due to the chip shortage to persist for a few quarters. Also, execution could see some delays.

Despite the weak revenues, the company’s operating profit was better, registering a 3 per cent growth, given the lower operating expenses.
 

Margins increased by 47-basis points (bps) to 25 per cent. It was led by a 64 per cent sequential increase in voice segment profit even as profits from the data segment remained flat over the last few quarters.
 

The margins came in at the higher end of the 23-25 per cent guidance for FY23 and may see some fluctuations, going ahead.

Balaji Subramanian of IIFL Research said with Tata Communications continuing to increase its headcount and inflationary pressures on tech hiring, FY23 operating profit margin could moderate from the 25 per cent seen in Q1, as costs could be back-ended.
 

The company has deferred its capex for Q1 of FY23, given supply-chain issues and delivery delays. It will be accelerated in the coming quarters.  
 

Positives for the company are a healthy balance sheet and a declining trend of debt.
 

Net debt was down 9 per cent to Rs 6,130 crore in the quarter from Rs 6,740 crore in the January-March quarter. 
 

Motilal Oswal Research believes that the continuous decrease in leverage should drive healthy net profit growth.
 

However, the management’s guidance of a 20 per cent increase in capital expenditure to $300-325 million can curb an improvement in free cash flows.
 

Though the company is confident about growth, most brokerages believe that it must reflect a consistent trend for the stock to be rerated.
 

Analysts at Emkay Research said, “While the management has been highlighting improving funnel rates, deal conversions, new product launches and double-digit revenue growth timelines still remain elusive. We reiterate that for any meaningful re-rating of the stock, revenue pick-up and consistency in guidance are essential.”
 

Investors should await improvement in revenue growth and margins before considering the stock. It is trading at over 8 times its enterprise value to operating profit on a one year forward basis.