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Buy Tata Communications Ltd For Target Rs.1,167

Deleveraging on track; await revenue recovery

* As expected, TCOM posted a 10% qoq dip in operating profit in Q3 – a quarter marred by seasonality and weak deal conversion. Yet, it was another quarter of healthy cash generation (Rs7.1bn) and reduction in net debt (down Rs6.6bn qoq).

* Despite the normalization in costs and deferral of network costs from Q2, operating costs were down 2% qoq and 8.4% yoy (due to cost-optimization efforts). Covid-19-related savings should continue to moderate from Q4 with spends required for revenue growth.

* The deal conversion has been impacted in the last few quarters, while management alluded to early signs of recovery. The consistent focus on trimming debt, revenue recovery and stronger deal conversion going forward are key monitorables.

* Our revenue and EBITDA estimates remain largely unchanged while earnings upgrade is driven by lower ETR. We continue to be constructive and maintain Buy rating with a revised SoTP-based TP of Rs1,167 (FY23E) vs. Rs1,073 earlier (Sept’ 22E).

Lower other income dents bottom line sequentially:

Lower usage-based revenues due to seasonality and delayed recovery in Covid-19 hit revenue and dented the profitability for the Data Services segment, with margins contracting 151bps qoq. RPAT was negatively impacted by lower other income (Q2 had a one-time gain from the sale of international investments), which was offset in part by lower tax charges. With the reopening of the economy, TCPSL managed to post an operating profit of Rs50mn vs. a loss in Q2. There was a one-off charge of Rs114mn due to interest on unpaid AGR provisions, taking cumulative AGR-related provisioning to Rs3.8bn.

Outlook:

While a relatively weaker Q3 print was anticipated, the key highlight of the quarter was the consistency in deleveraging and cash generation, despite the top-line being impeded, in our view. Along with this, double-digit revenue growth in the Data Segment and continued focus on reducing losses in the Innovation segment is the key for further re-rating in the name. We are projecting FCF generation of Rs56bn for FY21-23E. Going forward, with the resumption of businesses and the re-opening of the economy, we expect to see a traction in deal conversion and a recovery in the media portfolio as well. In our view, the government’s decision to offload its 26% stake in the company will provide flexibility to management on strategic decisions in the future. One of our primary concerns regarding TCOM has been the historical inconsistency on the delivery front (i.e., not meeting its own guidance). We believe that healthy performance in terms of deleveraging and cash generation every passing quarter will help to erase past memories of under-delivery on guidance. Key risks: 1) Any delay in scaling up the Innovations segment, and continued and elevated losses; 2) Poor conversion of new deals; 3) Increased competitive intensity; and 4) AGR demand of the DoT materializing.

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