Tata Comm performance yet to match estimates

Street will await consistent improvement in margins to re-rate stock

Tata Communications failed to live up to analysts’ expectations, missing their estimates and its guidance by a wide margin on the back of a muted March quarter performance. Revenues were down 2.4 per cent, sequentially, to ~41 billion largely because of a 14 per cent drop in voice revenues and flat data revenues. The data business accounts for about 72 per cent of its revenues, while voice and ATM businesses constitute the remaining 28 per cent.

Of the segments that constitute the data business, the performance of growth services has been particularly disappointing. The company reported a $14 million loss at the operating profit level for this segment, though it had planned to break even.

This, when the company has highlighted plans to improve the operating profit margin of its largest business segment from the present 17 per cent to 23-25 per cent by FY21, which is 600-800 basis points higher.

Most of the gains will come from higher revenue growth and productivity, especially in the growth and innovations segments. Cost efficiencies in manpower, network, and administration will also add to the gains. Analysts at Kotak Institutional Equities say the growth outlook seems aggressive, adding that their estimates are lower on account of the potential entry of Jio, disruption, and the lack of consistency Net sales Operating profit OPM (%) Adjusted net profit 5.55 0.41 -17.7 -23.1 -97 bps -42.9 in delivering on the guidance.

The other concern for the Street is the impact of a possible acquisition in the form of the enterprise business of Tata Teleservices.

Analysts at IDFC Securities believe that the possible acquisition is risky from the capital allocation perspective, as it does not materially strengthen the firm’s growth services portfolio. There might be limited demand for new generation services by small and medium businesses. Higher valuations could also add to the debt and increase leverage ratios substantially.

The stock, which is down about 10 per cent over the last year, trades at a reasonable valuation of 9.7 times its FY19 estimates.

While there is little doubt over the growth potential of the emerging services portfolio, the Street has not given a higher valuation to the company because of poor execution, disappointment on the operating profit front and weak return ratios.

Unless there is consistency in operating profit growth and margins, the stock may continue to underperform.