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Neutral Tata Communication Ltd For Target Rs.1,425

Slow pickup in revenue growth

* Adjusted EBITDA, after an INR500m one-off gain in 2QFY22, rose 8% QoQ (2% above our estimate) on healthy cost optimization, despite slower revenue growth of 1.7% QoQ, which is slowly recovering.

* We expect low revenue growth visibility given the low growth outlook in Connectivity (71% of revenue mix). This, coupled with weak EBITDA margin guidance of 23-25% v/s 26.7% at present, suggests double-digit growth could be challenging.

* However, we expect an improvement in margin from the curtailing of loses in the Incubation business, building in 10% EBITDA CAGR over FY21-24E, and revising EBITDA higher by 3-4%. We maintain our Neutral rating.

Normalized for one-offs, EBITDA up by 7.8% (2% above our estimate)

* Consolidated revenue rose 1.7% QoQ to INR41.7b (2% miss), propelled by 2.9%/4.6% growth in the Voice/Other business, while Data revenue was flat. Sequential growth is due to a gradual pick up in business and improvement across both Data and Voice segments.

* Data revenue, the key growth driver, remained flat sequentially at INR31.4b on the back of flattish performances from the Connectivity segment as well as moderation in Collaboration traffic. EBITDA grew 12.6% to INR10.4b, with margin at 33.4% on account of cost savings.

* EBITDA grew 12.9% QoQ to INR11.1b (7% beat) partly attributed to a one-off gain of INR500m relating to employee cost and the reversal of provisions for doubtful debts. Subsequently, EBITDA margin expanded by 270bp to 26.7%. Normalized for an estimated one-off gain of INR500m, EBITDA rose 7.8% to INR10.6b, with a strong 150bp improvement in EBITDA margin to 25.5%.

* PAT grew 43% QoQ to INR4.2b, whereas adjusted PAT (for exceptional items) stood at INR4.1b, up 42% QoQ (27% beat).

* Capex stood at INR3.9b v/s INR3.8b QoQ and INR3.2b YoY. Net debt declined to INR77.6b v/s INR80b in 1QFY22, despite a dividend payout of INR4b, on the back of better working capital mix and improvement in operating profit.

Highlights from the management commentary

* The management reiterated an improvement in deal traction across multiple markets, with ~80% of deals coming in from existing clients.

* The Data business is expected to pick up gradually on the backs of slower recovery in the Collaboration portfolio.

* Capex guidance stood ~USD250m for FY22, driven by an improvement in orders.

* EBITDA margin guidance was maintained at 23-25% for the long term from the current 26.7% as the management’s focus will be on OPEX to drive growth.

Valuation and view

* In the last three years, EBITDA CAGR has been strong at 21%. TCOM achieved a 1,050bp margin improvement though revenue growth, which has been slow as against our expectation of double-digit growth.

* Recent rejig in business segments and focus on driving higher deals in digitization led to healthy growth. The management commentary on deal wins and demand for networking solutions has been bullish since the onset of COVID19 pandemic. However, Data revenue, the key driver for growth, has seen a muted performance in the last few quarters.

* We expect low revenue growth visibility given the low growth outlook in Connectivity (71% of revenue mix). This, coupled with weak EBITDA margin guidance of 23-25% v/s 26.7% at present, suggests double-digit growth could be challenging. However, we expect an improvement in margin from the curtailing of loses in the Incubation business, building in 10% EBITDA CAGR over FY21-24E, and revising EBITDA higher by 3-4%.

* Deal wins and deal-to-revenue conversion will be the key monitorable going forward to achieve double-digit earnings growth.

* We maintain our neutral rating with a TP of INR1,425 (assigned an EBITDA of 9x/3x to the Data/Voice business). We maintain our Neutral rating.

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