Why are analysts recommending telecom stocks?

Moneycontrol Bureau

Telecom stocks are slowly creeping back into the game. These beaten-down stocks have gained significantly in the last month. Both Bharti Airtel and Idea have gained almost 16% each since October 19, while Reliance Communication has risen 5% in the last 15 days.

Experts suggest there are triggers to buy telecom stocks. Moneycontrol unravels the reasons behind this new-found optimism. 

Pricing power set to return 

Most analysts feel that if the competitive intensities were to go down, the telecom companies will be able to raise their tariffs significantly from here.

Sandeep J Shah of Sampriti Capital sees a case for a long-term investment story in telecom. "I think the real conviction would come when you actually start seeing pricing power," he adds.

Various experts believe that clarity on refarming and reduction in spectrum price have also made the sector look-worthy. There are expectations that tariff rates will move up instead of going down.

In the past, telecom companies tried to revise tariff upwards, but failed. For instance, Bharti Airtel had been unsuccessful in its attempt to raise prices not once, but twice. The reason behind this is rather odd. The market leader with largest marketshare or biggest subscriber numbers do not set the prices. It is set by the lowest cost producer, who could be the new kid on the block with abundant spectrum and fixed cost. "So every little subscriber they get just adds to their revenues," Shah explains to CNBC-TV18.

Gautam Chhaochharia of UBS thinks that the new small players do not really have a business case. "So, you will have a market where Bharti, Vodafone and Idea will be the strong players and you will see a pricing power coming back to these companies. That, will be the real big catalyst," he elaborates.

How 2G auction has changed the game

With 2G auction, it has become clear that only serious telecom players will survive in this game. It is significant to note that the number of players in the telecom industry have reduced and entry barriers have gone up. Once the regulatory overhang and the auction event is behind us, incumbents will be in a very strong position in respect to the market.

Chhaochharia strongly believes that investors will realise that the business case for new or smaller players is not really that credible. "This means that the industry structure post this auction will be far more supportive in terms of profitability and pricing power," he explains.

Agrees PN Vijay, Portfolio Manager, www.askpnvijay.com that the government by cancelling licences has triggered a consolidation in the sector. "We are going to be left with only 4-5 serious players which is good for India."

Stocks to watch

Bank of America Merrill Lynch (BoAML) upgraded both Bharti Airtel and Idea Cellular to "buy" from its earlier "neutral" rating. According to BoAML, deep (20-40%) underperformance over last 12-months, policy decisions in areas like spectrum pricing and strong FY14-15 earnings growth (+30-40%) should help ease valuations.

Among the listed stocks, Reliance Communication is likely to see few takers because of various corporate governance issues related to the company. "So, that will lift Bharti and Idea Cellular," PN Vijay says. Going by Chhaochharia expectation that Bharti can lap up 20-25 percent upside from current levels, it is cetain that UBS is bullish on the sector.

How far can Bharti go

Adding that the failure of 2G auction has done wonders to Bharti Airtel, PN Vijay feels that the stock is likely to rally to Rs 350 as it has strong bottom. "So, around Rs 350 it has enough steam to go but at that time you will have to relook at that stock," Vijay explains.

However, Sudarshan Sukhani of s2analytics.com is not betting on Bharti at all.  "Bharti Airtel has resistance at Rs 320-325. I would be little afraid of going long in Bharti now. Stocks don't  not keep on going up and especially when everyone starts recommending them. That is a cause for worry. We should step aside from Bharti, take profits. This share will also come down and give us a better entry price. It’s not a good location to buy".

Failed 2G spectrum -Recap

The government managed to mop up merely Rs 9,407.64 crore from the 20-year lease-out of scarce radio waves. This is much lower than Rs 40,000-crore (the target was later lowered to Rs 30,000 crore) set by the government. The industry had complained that the reserve price of Rs 14,000 crore (for 5 MHz) for a pan-India licence fixed by the government was too high and that was what kept the bidders away.

However, Telecom Minister Kapil Sibal believes that lowering of the reserve price would not have netted more money. He had earlier said the outcome of the spectrum auction was a result of "market dynamics at play".

nasrin.sultana@network18online.com