Bharti Infratel downgrade cycle likely to continue over next three quarters

Stock could see more pressure as smaller operators scale down operations and Idea-Vodafone merger nears closure

The de-rating and downgrade cycle for Bharti Infratel which started a month before is expected to continue over the next three quarters. December quarter numbers will give an idea of the pressure the company faces, given tenancy losses from RCom's wireless business exit and shutdown of operations by Aircel in six circles.

 

Revenue growth is expected to be flat on a sequential basis. This will continue in the March quarter as Aircel curtails operations. From the first half of FY19 as Vodafone and Idea Cellular merge operations, their overlapping tenancies would get accounted for loading instead of separate tenancies.

 

Himanshu Shah of HDFC Securities had in a report earlier this week said multiple de-rating of the stock was inevitable. He expects a potential reduction of 60,000 to 65,000 tenancies from the merged entities. He believes Bharti Infratel's operating profit will be impacted by 15 per cent and earnings per share (EPS) by 25 per cent. With the impending business risk and structural weakness, the brokerage has cut its target for the company from 25 times to 20 times the one-year forward estimated price to EPS multiple.

 

The other worry highlighted by analysts is the renegotiation and price reduction risk at telecom operators struggling to maintain their revenue growth while keeping and pursuing subscribers. While the Sreet was expecting consolidation to help the incumbents, a new pricing war has erupted. This will keep profit under pressure and force operators to cut costs as much as possible, a structural risk for telecom tower companies.

 

If this happens, given the economies and operating costs, a fall in tenancies and rentals will have a larger impact on profit. A five per cent fall in rentals per tenant would have a 11 per cent impact on EPS for Bharti Infratel. Though weaker players account for less than 10 per cent of its tenancies and the impact will last for a couple of quarters, the Street will watch for any exit penalties Idea/Vodafone will have to cough up on merger. The penalty is 35 per cent of the balance period rental if a tenant has completed five years.

Bharti Infratel

Bharti also has to take care of growth worries. Analysts at IIFL say with Reliance Jio's tenancy momentum still slow, Bharti's earnings scorecard is likely to be weak. Jio is the only source of growth for the tower industry at this point. Excluding Jio, tower company revenues are declining.

While there are significant negatives, analysts highlight a couple of positives for the stock. First, if any merger or acquisition by Bharti with Indus or selling out their stakes by current promoters Idea Cellular, Bharti Airtel and Vodafone to independent entities come through, this could help negate the operator-owner discount and lead to higher rentals. Perceived lack of independence was a key reason why the Street had a negative view of the stock.

 

IIFL analysts, however, believe this might not happen, as towers could be considered a strategic asset after RJio's acquisition of RCom's assets, and after the deal, Jio will have 90,000 of its own towers.

If the deal were to happen, the company will benefit from an improving capital structure, as Rs 60 billion of cash is not giving an adequate return on capital. Unlike service providers, infrastructure companies such as Bharti Infratel are comfortable on leverage.

 

The other positive is the pace of network spending. If data momentum and tower rollout increases, the stock could see a rebound as companies would seek to add to loading, as well as become tenants on new towers to increase coverage of their services.

 

Tower companies could also explore opportunities such as in building solutions, Wi-Fi hotspots and fiberisation. In addition to revenue opportunities, what will aid profitability, according to ICRA, are reduction in power expenses, primarily diesel consumption. The sector could also explore the real estate investment trust model to expand its investors.