Weak Q3 show, near term growth worries for Tata Communications

Most brokerages are, however, positive on the long term growth trajectory

The stock of network services major Tata Communications shed 5.4 per cent on Friday after its December quarter (Q3) performance missed Street estimates and led to downward revision of profit estimates.

Though brokerages are positive on the firm’s long-term prospects, led by the digital platform and services business, there could be near-term challenges on the revenue growth and margin expansion fronts.

The company’s consolidated revenues were flat on a sequential basis as a 3 per cent growth in the data business was offset by a sharp decline in voice and other segments. The voice segment, which accounts for 13-15 per cent of revenues, dipped 8.6 per cent sequentially and 17.8 per cent year-on-year (YoY) on the back of falling volumes and realisations.

The data business, which contributes over 80 per cent of consolidated revenues, however, posted higher growth of 3 per cent. This comes after two quarters of sequential growth in the 0.6-1.1 per cent band. The core connectivity solutions segment, which accounts for the lion’s share of data business, posted a growth of 1.6 per cent. Though this was lower than estimates, the digital platform and incubation segments posted better-than-estimated growth at 5.2 per cent and 26.4 per cent, respectively.

Core connectivity solutions growth was impacted by the bandwidth rationalisation as the return to offices has been gradual. This is expected to recover in the coming quarters as the effect of the new variant diminishes.

Weak revenue growth and higher expenses added pressure with reported operating profit falling over 5 per cent below expectations. Adjusted for the one-off gains in the previous quarter, the metric was up 1.8 per cent sequentially.    

Aliasgar Shakir and Harsh Gokalgandhi of Motilal Oswal Research expect lower revenue growth visibility since connectivity (71 per cent of the revenue mix) has a low growth outlook. This, coupled with flat operating profit margin guidance of 23-25 per cent as compared to the current high of 25.9 per cent and overall double-digit operating profit growth, could be challenging, they add.

While the order pipeline appears healthy, closure of large deals were impacted in Q3 as corporates delayed expansion plans. The order book growth is expected to stabilise in the coming quarters and will be a key monitorable. The company’s confidence on growth is also reflected in its plans to hire 1,000 new recruits in FY23, mostly in the sales and technical department.

A key positive in the quarter was deleveraging, with net debt dipping by Rs 570 crore sequentially to Rs 7,189 crore on better working capital management.

Though most brokerages have cut their operating profit estimates marginally over the next couple of financial years, they believe the company could gain significantly from its digital platform/emerging business segments.

Say Sanjesh Jain and Akash Kumar of ICICI Securities, “Tata Communications is in a sweet spot with corporates looking to significantly invest in upgrading their networks, and adoption of next-gen connectivity. The company’s ability to provide digital services only adds to the total addressable market.”

While the core connectivity solutions market is expected to be flat between FY20-24, emerging services are slated to grow at 17 per cent over this period and could aid in the company’s overall growth.

At the current price, the stock is trading at 18 times its FY23 earnings estimates. Investors can consider the stock for the long-term on dips.