3QFY23 Results Update on Tata Communications, Motilal Oswal

TCOM revenue grew 2% QoQ (in line), but EBITDA declined 5% QoQ (5% miss) due to weak data EBITDA margin. Management has reiterated its focus on growth. TCOM continued to garner a 7% FCF annualized yield and healthy ROCE of 28%.

We have reduced our consolidated EBITDA estimate and now expect a revenue/EBITDA CAGR of 12%/11% over FY23-25. While growth in data EBITDA has been soft, healthy FCF generation and continued deleveraging provide a silver lining, aiding valuations. We maintain our Neutral rating.

EBITDA declines 5% QoQ on weak data margin; FCF remains healthy

• Consol. revenue grew 2.1% QoQ to INR45.3b (in line), led by 3% QoQ growth in the data segment. Voice segment revenue declined 4% QoQ, while other revenue grew 4% QoQ. The tailwind from INR depreciation of 3% QoQ supported revenue growth.
• EBITDA declined 5% QoQ to INR10.8b (5% miss), affected by a 6% QoQ decline in data segment EBITDA. As a result, consol. EBITDA margin declined 170bp QoQ to 23.8% (100bp miss), in line with the management’s guidance of the 23-25% margin range.
• Interest costs jumped 26% QoQ due to an increase in the borrowing cost amid rate hikes globally. Accordingly, adjusted PAT fell 14% QoQ to INR4b (in line).
• Committed capex decreased 7% QoQ to INR3.9b in 3QFY23 from INR4.2b in 2QFY23. Net debt/gross debt declined marginally by INR1.3b/INR0.9b to INR63b/INR77b.
• FCF declined by 45% QoQ to INR3.5b from INR 6.2b in 2QFY23, led by an 18% QoQ decline in CFO due to working capital changes. However, 9MFY23 FCF yields stood at 7% (annualized) v/s 6% in FY22.
• The company posted RoCE of 28.4% v/s 28.1% in 2QFY23 (FY22 ROCE at 25.4%).

Key takeaways from the management interaction

• The company maintains its double-digit growth ambition on the back of 23-25% EBITDA growth expectation in the DPS segment and 25-30% RoCE guidance.
• Margins are affected by inflation in employee and energy costs, along with long-term contracts, which offer lower pricing power.
• High FCF allows TCOM to explore organic and inorganic opportunities. It acquired the Switch business for USD58.8m.
• The order book continues to grow every quarter and the sales funnel is improving, along with the win rate.

Valuation and view

• We have reduced our consolidated EBITDA estimate and now expect a revenue/EBITDA CAGR of 12/11% over FY23-25.
• The data segment reported double-digit YoY growth and management has reiterated improved funnel of new deal, but its translation into meaningful growth will be key for TCOM to achieve double-digit earnings growth.
• The management’s guidance of a 20% increase in capex to USD300-325m can curb potential improvement in FCF going forward. Yet it could continue to garner healthy ROCE of over 20% and a high-single digit FCF yield. The decrease in leverage could be a silver lining, which could drive PAT growth.
• We maintain our Neutral rating with a TP of INR1,200/share (assigned 9x/3x EBITDA to the Data/Voice business). Sustained improvement in earnings growth visibility will be vital for valuation rerating.

For report, http://ftp.motilaloswal.com/emailer/Research/TCOM-20230124-MOSL-RU-PG012.pdf

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