RCom margins face squeeze, but positives abound

Citi sees declining business and high leverage -- dual network strategy and 3G -- as some of the headwinds faced by Reliance Communications (RCom). It has handed down RCom a 'Buy/High Risk' rating with a price target of Rs 127 per share. The company currently trades below its replacement value of Rs 120 per share, which according to Citi adequately covers its business- and leverage-related concerns.

Here is a detailed fact parade by Citi on Reliance Communications. Operating profit of the company fell short of expectations, but masked some of the positives. Fourth quarter earning before interest, tax, depreciation and amortisation (EBIDTA) net of Indefeasible Right of Use (IRU) income stood at Rs 1,580, which edged lower 5% on a Q-o-Q basis.

RCom currently trades below its replacement value of Rs 120 per share, which according to Citi adequately covers its business- and leverage-related concerns. Reuters

The global business slid 4% for the March quarter compared to the previous one. The wireless EBIDTA may have dipped 3% during the two corresponding quarters, but there were some encouraging signs in the form of stable revenue per minute and revival minute growth. Total minutes crept up 3% on a quarter-on-quarter basis, which were flat or declining over the last three quarters. Revenue per minute has been stable for six quarters now. Wireless margins came under pressure as it plunged 160 basis points on higher network operational expenses (CDMA) and should remain squeezed in the next 1-2 quarters due to 3G operational costs.

The management's focus on the non-voice segment is evident from the fact that the division contributes 20% of the revenue (higher than other GSM incumbents). Reliance Communications has posted Rs 2,550 crore of upfront revenues related to non-cancellable/refundable contracts related to bandwidth sale in the fourth quarter. Adjusted for this, the global EBITDA at Rs 380 crore moved down 4% on a Q-o-Q basis. The management attributed this to the pricing pressure in private contracts as well as tendered government wins. Broadband revenues surged 12% between the two quarters on the basis of average revenue per user (ARPU) increase. The operating profit, however, was flat as margins shrank 390 basis points.

The management unveiled 78,000 tenancy units on its 50,000 tower portfolios, imputing 1.56 times, which is expected to increase 0.2 times from 3G. The net debt, at Rs 32,000 crore (net of equipment payable), has come down by Rs 400 crore . For FY12, capacity expansion guidance of Rs 15,000 crore was lower than Citi's estimate of Rs 27,000 crore, which points to the company's focus on deleveraging.

Citi believes that the low capacity guidance is unlikely to impact the company's performance in the near to medium term, given the cushion of low network utilisation.