Stay away from telecom stocks until November: Sanju Verma

Sanju Verma, MD & CEO, Violet Arch Capital Advisors expects further EPS downgrades on Bharti Airtel post its disappointing first quarter performance. 

Bharti Airtel, the country's largest telecom company, on Wednesday said its net profit fell 37% to Rs 762 crore during April-June as stiff competition, along with regulatory hurdles, higher capital expenditure and licence fee outgo, weighed heavily.

With results falling short of analyst expectations, Bharti was the worst-performer on the Bombay Stock Exchange, losing 6.6% to close at Rs 274 yesterday.

Verma says the stock correction is pricing in EPS downgrades. "We need to see progress on Bharti Infratel listing," she said on what could help the company ahead. 

Airtel has appointed a Committee of the Board of Directors to consider a public offer of its telecom tower unit Bharti Infratel Ltd (BIL) by selling up to 10% stake.

The 2G auction and spectrum bidding will be key trigger for telecom companies, Verma believes. However, she adds that it would be best to stay away from the sector till November of this year.

Shifting focus to the auto sector, Verma picks Mahindra and Mahindra as her top pick, followed by Maruti Suzuki.

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Here is the edited transcript of the interview on CNBC-TV18.

Q: What do you do with Bhart Airtel now?

A: The government has literally killed a show piece sector, it was a show piece two and half to three years back. If I have to look at Bharti dispassionately, the negatives are pretty much well known, regulatory pressures, higher tax outgo, increased depreciation costs etc.

Looking at the flip side, I think the positive is that here is a company despite all the regulatory pressures have still managed to show an EBITDA margin of 30% plus. Obviously, that is a huge let down from the 40% plus that we are used to but, clearly those days are passing.

The telly media business has done well with ARPUs at Rs 962. The data business has done well; the DTH revenues are up 25% year on year (YoY). Clearly, operationally things are not as bad. Of course prima facie the fact that net profit is down 37% YoY and 24% sequentially is not flattering.

The point I am trying to make is yes, EPS downgrades are certainly in the offing. So consensus EPS which stood at Rs 17 for Bharti for FY13 and at about Rs 24-25 for FY14 clearly will see further downgrades. That said, the feeling I get is that maybe the stock has already been knocked out from Rs 450 levels, 18 months back. It is down to around Rs 265 and still struggling to stay there and that is a huge fall.

My sense is that the key things to watch out for in terms of how this stock will move will primarily depend on a) what can Bharti do to bring down its net debt to equity, which currently stands at more than 3 times to about 1-1.5 times? I think that is the clincher and that will again depend on whether they are able to raise close to USD 750-800 million, which is their stated target divesting part of Bharti Infratel, maybe 8-10% or thereabouts. The experience of Reliance Communication trying to list Flag Telecom is hardly flattering.

My point is, here is a company which has an overall debt of Rs 60,000 crore but, a lot depends on what the government decides to do with respect to the auctions that are now slated to held, not in August but in November. I think the winning price bid will determine how 2G players pan out with respect to their performance going forward.

One must remember that the reserve price here is not really material. What is material is how the auction process pans out? My personal sense is that new players like Videocon, Uninor, Loop, Telenor are already loosing anywhere between Rs 5-8 crores per day. Every day lost in the auction process means more losses mounting up for the new players.

I think the auction process is not meant for the new players though, initially that was the agenda because they squeezed to the hilt. It is clearly going to be for incumbents. What will matter to incumbent players like Bharti or Idea or Vodafone is what will be the winning price bid because the winning price bid will determine how much the incumbent pay over and above the 4.4-6.2 megahertz spectrum that they already have.

What will be the Spectrum usage charges? Will it be 3%, 5% or 8%? What is the outcome of the presidential directive with respect to a whole host of issues including whether the government decides to make internet telephony free?

If the government decides to make internet telephony free because there is lot of noise around that then clearly incumbents like Bharti, Vodafone and Idea are going to suffer big time. The biggest beneficiary will be Reliance which already has a Broadband Wireless Access (BWA) network in place.

I feel that it's not easy to take a call on Bharti because there are too many complexities that have to be taken care of. Bharti’s licenses come up for renewal in 2014. Now a lot depends on how Bharti plays this. It will have to surrender its 900 megahertz spectrum and take 1800 mh spectrum, which is less efficient, from the government.

At what price it finally manages to get its 2014 license renewed for another 10-15 years, I think will again be a clincher. But, as things stand today, with a base price of Rs 14,000 crore for 2G Spectrum of 5 megahertz, incumbents like Bharti, Idea and Vodafone will have to combine and shell out something like Rs 95,000 crore simply to be in business.

One must not forget that out of the Rs 2000 crore debt which the Indian telecom industry owes to the Indian banking space, Rs 100,000 crore plus of debt is owed just by the top three players. So a lot depends on how the regulatory things pan out going forward.

I think it's too soon to take a call and write this stock off or go the whole hog and buy it. But, given a choice at this point in time, I would stay out of telecom until there is clarity on the reserve price, on the outcome of the presidential directive so on and so forth. That means we will have to wait till November.

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Q: What do you do with Cairn? How do you read this news of the CEO quitting? It has caused some consternation amongst institutional investors.

A: Yes, that clearly seems to be the case if the knock that the stock has received today is anything to go by. That said. I believe maybe this is just a kneejerk reaction. While Rahul Dhir stepping down is certainly a disappointment, I think operationally this is a very strong company and one will obviously have to give due weightage to the fact that here is a company which for the June quarter reported a stellar set of numbers.

I still can't get over the fact that they reported a net profit of close to Rs 3,800 crore which was up some 75% QoQ. People have come back saying that a large part of that profit growth was driven by close to Rs 860 crore forex gain, true. But even if you strip out the exceptionals, Cairn still grew by close to 60% sequentially.

I think by a long margin this has clearly been one of the most stellar performances by a large cap, not only within the broader oil and gas space, but otherwise as well. As I love to tell anyone who cares to hear, look at it this way, this is a company which for the last two years on an average has been making a profit after tax of between Rs 6,000 to Rs 7,000-7,500 crore odd.

This despite the fact that it shells out something like Rs 3,800 crore by way of royalty or cess to the government, another Rs 1,600-1,700 crore as profit petroleum and another Rs 1,200-1,300 crore every year by way of other surcharges and taxes. Despite that the EBITDA per barrel for Cairn is about USD 60. It also has PAT margins of close to 60% and gross margins of close to 75-80%.

The point that I am trying to make is, the operational levers are very strong. The performance of the company is something that has to be seen on a standalone basis as well, not withstanding the changes and the shuffling at the top management and purely from an operational perspective. If I have to put my neck out, I would say Cairn and ONGC within the upstream space would be the pecking order if I have to go and buy the space.

Q: Big results out from Tata Motors today. It fell to almost Rs 200, but has clawed back to Rs 240. Where do you stand on that stock now?

A: I had mentioned earlier that the pecking order at our end within the four-wheeler auto space is M&M, perhaps Maruti for people who love high-beta and high risk and higher returns and of course Tata Motors. I stick by that.

M&M continues to be our top pick. What a stellar set of numbers yesterday. No wonder the stock has gone up by 5% plus. Coming back to your query on Tata Motors, I think the standalone numbers will continue to disappoint but on a consolidated basis you are likely to see a 30% plus growth in both revenues and EBITDA.

Clearly the PAT growth will also be in the region of 25-30%, maybe higher. The only worry is the EBITDA margins. A lot has been said about it. If the EBITDA margins hold onto the 15-16% band then there is nothing to worry, but if the margins at the EBITDA level come down to 14% or below, then I think the stock will react negatively.

I think that is the key clincher and the key swing factor which will determine the stock price movement, at least over the next couple of trading sessions. But that said, M&M certainly takes the cake when it comes to a single stock that you need to buy in the four wheeler space. Incidentally, we have revised our price target upwards there, from Rs 820-853 which works out to an 18% appreciation or thereabouts over the next 12-18 months.

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Q: The space which is just not showing any improvement to investors with performance is the infrastructure space. Punj Lloyd was weak, GVK was very weak yesterday and we would probably hear more of the same from GMR. How do you approach these names now?

A: You are right. The infrastructure space still has a long way to go. Clearly, stock prices tell you anything. The fact that the infra index in the last couple of months is down anywhere between 8-10% after doing zilch over the last two years tells you a lot. The key here I think again is interest cost.

Let us take the example of say GMR which is likely to declare numbers. The fact that the stock has started weakening ahead of that tells you it’s a precursor of things to come. Here is a company which is likely to do a turnover of about Rs 2,200-2,300 crore. Yet, I think they might do a loss of about Rs 300-320 crore odd purely driven by the fact that interest costs for the quarter are likely to be anywhere in the region of Rs 460-500 crore, which is huge.

The point I am trying to make is that interest costs as a percentage of sales have been gradually and staggeringly increasing incrementally for the infra companies. I think that is the Achilles’ heel. For instance, look at L&T which was a bellwether within the infra space. Seemingly, the numbers look great. It has been a personal favourite. It reported 20% growth in sales, 16% jump in profits. Of course the margins were at 9% and that came in as a disappointment.

But the point is even at the operating profit level, if you strip out the other income then the operating profit for L&T was down 5%. The point I am trying to make is that I think order intake has not materially improved. There are still a lot of regulatory issues. Higher interest and depreciation costs have been eating into the revenues. So no wonder that while a company is showing 20% growth, that is not translating into profits.

I think that is precisely what we have seen in the infra companies as well. 17% top-line growth, 17% operating profit growth, but net profit growth is barely 2-3%. That tells you the story that unless and until there is a material downward shift in interest costs which for some companies is as high as 30% of net sales, the infra index is not likely to outperform or even put its head above the water in a rush.