India Strategy-Strong start to FY22: Motilal Oswal Financial Services Ltd

Corporate earnings in the first quarter of FY22 have been in line with the elevated expectations, aided by the deflated base of 1QFY21 and localized and less stringent lockdowns v/s 1QFY21.

Sectoral earnings have diverged sharply on account of the impact of second Covid-19 wave and higher commodity prices impacting the margins of select sectors (Auto, Consumer Staples, and Durables).

On the flip side, cyclical sectors such as Metals and Oil and Gas (O&G) have benefitted, driving in-line aggregate earnings.

For the MOFSL Coverage Universe, the earnings downgrade to upgrade ratio for FY22 stands at 6:5 – as 59 companies have seen downgrades > 5%, while 47 companies have been upgraded by > 5%.

Management commentaries across the board indicate an improvement in the demand environment post Jun’21, led by the easing of restrictions and sharp reduction in active Covid-19 cases. The pace of vaccination has picked up – average daily doses in August stand at 5.2m doses/day, v/s 4.3m doses/day in July.

Amid the likelihood of a normal monsoon season, we expect corporate earnings to recover as economic activity picks up and pace of vaccination accelerates further.

1QFY22 has been an in-line earnings season for the MOFSL Universe. ~42% of companies in the MOFSL Coverage Universe have beaten our estimates, while 39% have missed our estimates.

Nifty sales have been in-line (50% YoY; est. 48%), while EBITDA/PBT/PAT growth has come in at 41%/103%/101% YoY (est. 38%/89%/94%). Of the Nifty constituents, 42% have reported beats on our PAT estimates, while 34% have missed expectations.

-Telecom: Lockdowns halt subscriber and ARPU growth-

Telecom: While most sectors were reeling under the pressure of the nationwide lockdown led by the second COVID wave led lockdown, the Telecom sector was up and running, with a limited impact on earnings. Operators witnessed marginal revenue impact owing to a) the free extension of plan validity in May’21 and b) SIM consolidation and loss of revenue from feature phone subscribers due to the low economic impact of the pandemic. Subsequently, revenue grew 2%/4% QoQ for Bharti/RJio, while VIL continued to be impacted by market share loss (5% revenue decline). TCOM’s revenue growth was flattish at 1% QoQ.

Subscriber market sees SIM consolidation: The Indian Telecom market is witnessing the consolidation of the dual SIM card phenomenon. Subsequently, Bharti held its position in terms of overall subscribers and added 4m/19m data/4G subscribers. While this was much lower than the 14–15m addition in the last few quarters, the impact on additions was due to the lockdown. Although, RJio continued its steady pace of 14.4m additions – which is estimated to have come from the recent JioPhone launch – and saw limited impact from the lockdown. However, VIL drove the industry consolidation with subscriber decline of 12m, with data/4G subscribers also declining by 4m/1m. This is attributable to the lockdown – however, even in the previous lockdown, it did not see much subscriber recovery.

ARPU trends muted: As telcos provided free extension in validity periods and the lockdowns also impacted recharge availability, a marginal impact was seen on ARPUs. Nevertheless, Bharti/RJio saw gradual improvement to INR146/INR138. On the other hand, VIL saw ARPUs decline 3% to INR105 – we estimate the lockdowns to have triggered some consolidation in the market.

Margin profile: Despite moderate revenue growth, both Bharti India Mobile and RJio saw marginal improvement in EBITDA margins by 160bp and 10bp, respectively. On the other hand, VIL’s revenue decline sharply impacted the EBITDA margin by 540bp on a reported basis.

Capex intensity remains high: While RIL did not disclose specific capex for RJio, it did indicate that it had completed the deployment of spectrum acquired in the recent auction, which may have expanded capacity significantly. Similarly, Bharti mentioned that its high India Mobile capex of INR43.7b was primarily towards the deployment of spectrum acquired in the recent auction and intensifying site coverage.

Leverage remains high for Bharti/VIL: VIL’s earnings and cash position have continued to hurt its leverage, with debt (including the AGR liability) ballooning to INR1,907b (up by INR107b). Bharti, despite its strong cash flows, also saw debt increasing by INR110b to INR1,265b (net debt to EBITDA of 3x).

Top picks: Bharti Airtel

Positive surprise: Bharti Airtel

-Guidance highlights-

• Bharti: 1) June–July subscriber and ARPU traction indicate strong and healthy recovery from the lockdown impact. 2) Airtel’s customer segmentation strategy stresses its focus on the top 50m customers, along with 500m aspirers, which are high-ARPU customers that contribute 85–90% to the market. 3) FY22 capex is expected to trend lower v/s FY21, and higher capex in 1QFY22 was attributable to the deployment of spectrum acquired at the recent auction.
• VIL: 1) The management aims to scale up higher ARPU subscriber programs in partnership with OEMs and NBFCs for 4G devices. 2) VIL plans to achieve INR40b in annualized cost savings by CY21. It has already achieved ~70% of its target at the end of Jun’21. 3) Capex run-rate for FY22 is expected to remain at levels similar to the last two quarters.
• Indus Towers: 1) Opportunities in 5G (telcos already doing trial-runs), in building solutions, and in small cells, among others, remain high. Moreover, with reducing churn, tenancies should remain healthy. 2) Energy margins may be reversed as customers shift from the pass-through to fixed energy model, and both parties would benefit from the investments to reduce energy costs.
• Tata Communications: 1) The deal funnel has improved and is expected to drive revenue, but it is seeing longer lead times to close large transformation deals. 2.) Capex guidance of ~USD250m for FY22 is driven by new orders, maintenance capex (2% of revenue), and strategic capex. 3.) The EBITDA margin guidance is maintained at 23–25% over the long term.

CT Bureau