Q2 topline above expectations on growth across board, bottomline inline
Zee’s topline in Q2 FY19 grew by 24.9% yoy as both advertising revenues as well as domestic subscription revenues grew strongly. Advertising revenues grew by 23% yoy and 5.6% qoq continuing with the trend observed in the last three quarters. This is a result of heavy advertising spends from the corporates and success of its channel portfolio. Subscription revenues were robust at 26% growth in the domestic markets on early closure of some contracts and Phase III monetization. Reduction in operating costs despite launch of Zee5 in Q4 (from 37.7% in Q1 as a % of sales to 36.8% in Q2) has led to strong margin performance at 34.2% up 230 bps qoq and 320 bps yoy. Even the other expenses and advertising costs as a % of sales along with employee costs have reduced, thus leading to superior margin performance despite original programming hours inching up across the board. In Q1, Zee gained market share on Hindi GEC front (#1 non sport player with a market share of 19.9%, a growth of 70 bps qoq from 19.2%), while it remained either #1 or #2 in all the regional businesses apart from Tamil (a close #3). Higher depreciation led by increased movie inventory and investments in digital as well as TV content and lower other income somewhat restricted bottomline growth which adjusted for one off in the form of cash coming in from the sale of sports business last year same quarter was down by 13.2% yoy at Rs. 4.1 bn.
Advertising revenues to grow higher than industry as dominance persists
Zee’s domestic advertisement revenues growth in Q1 came in at 23.3% yoy. This is a decent growth across the verticals of the Ad business. Hindi GEC continued to be the #1 non-sports channel with more than a percentage growth in the viewership market share at 19.9% yoy, growing 70 bps qoq. Dominance in the regional space, mainly in Marathi (>50 % market share), newly achieved leadership in Bangla market, Bhojpuri channel Big Ganga (now Zee Ganga) & Oriya channel (Zee Sarthak) along with resilience in Telugu( close 2nd ), Tamil (3rd with an improved market share) and Kannada (2nd) markets will further provide a traction in the ad revenues growth. The company is about to enter Kerala markets through its Malayalam GEC Zee Keralam in December. Furthermore, market share will receive a traction from higher spends coming on the movie basket (mainly Hindi and Marathi) by Zee. Zee is expected to add further in its investments into channel as well as movie content. The company has also increased the number of Original Programming Hours at close to ~30-32 hours from 27 hours yoy average. FMCG , Automobile, Telecom and e-commerce verticals have been increasing their ad spending off late, mainly in the e-commerce space now with an ongoing intense battle. Despite advertising revenues having grown at at an average of 21%, management expects some moderation in it on high base of H2 last year. Industry is expected to grow at 10-12%, while Zee expects to grow at higher teens. We have projected 18%/16% growth for Zee’s ad business for FY19E/20E.
Potential for digital business remains immense
Post the launch of Zee5 in February, it has gained #2 spot among all the digital platforms in India. In September, the company reported a growth of 190% in the number of Monthly Active Users (MAU) over April, at 41.3 mn. During the same period, video views grew by 340% and videos viewed per user doubled. Zee charges Rs. 99/per month per user, while users spend average 31 minutes per day on Zee5. The company also targets to launch 150 exclusive movies across languages over the next twelve months. Zee5 will also launch content from various foreign countries dubbed in multiple Indian languages. The growth trajectory shown by Zee5 is creditable as it has happened without any telco contracts. We expect this business to add strong revenue stream shortly and turn profitable in coming 1-2 years.
Subscription business takes us by surprise, though Q2 growth is not sustainable
Zee’s domestic subscription revenues in the quarter witnessed a growth of 26% in Q2 FY19. The growth was in fact driven by monetization of Phase III implementation and some contracts fructifying earlier than expected. The new tariff order by TRAI will come into play from January 2019 and is expected to be profitable to the entire value chain including the broadcasters. Going forward the dividends arising from implementation of Phase III and IV of digitization will continue to pay rich dividends. On the international revenues front (1.9% growth in Q2 and 6.9% de-growth in Q1), new content may help Zee to somewhat offset the issues in Middle East and Bangladesh, but we expect a lower single digit growth. However, we believe Q2 growth is not sustainable as we have seen some lumpiness in revenues coming from preponement of contracts materializing. Hence we have maintained our subscription revenues growth at 12%/14% for FY19E/20E respectively.
Outlook and valuation
We anticipate good growth in Zee’s ad revenue growth as a broad based sectoral spending on advertising has been witnessed in the quarter. Market share gains have already taken place on the Hindi GEC front, regional channels, RBN and 9X acquisitions, newly launched channels, rising original programming hours and the movies basket (Marathi and Hindi) continue their excellence. Even internationally, the revenues are expected to move well on new content. This will enable ad revenues to grow at a decent pace in the 18-20% range for full year. In line with the stupendous performance shown by OTT channel Zee5 which was just launched in February would open an altogether new stream of revenues with its heavy investment in original content over the next 12 months. Entry into new market like Kerala will be an additional lever to the business. Subscription revenues will be driven by implementation of digitization which has started to pick up pace across the country. We believe the company can easily achieve their conservative margin guidance of ~30% (34.2% in Q2). However, we believe the 34% margins are an aberration as heavy investments in Zee5 content in India and its launch in North America may pull down the margins from Q2 levels. Robust FCF and stable dividend policy will allow the company to be a secular growth story. We have slightly reduced our margins and thereon our FY 19E and FY 20E estimates slightly on higher depreciation (stemming from movie inventory), higher Zee5 content costs, launch costs in Kerala and lower other income. We have BUY rating on the stock (@ 30x FY 20E earnings), with a reduced TP of ₹ 573. Key concerns on the stock are 1). The proliferation of digital diaspora, which may eat into TV revenues. 2). Higher than expected cost escalation associated with digital business.
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