Better revenue growth key for Tata Communications stock

The Street will also keep an eye on margins as marketing costs start to impact profitability

The Tata Communications (Tcom) stock slipped 7 per cent on Wednesday after its December quarter performance missed the Street’s expectations. Besides the Q3 showing, what may have added to the stock’s decline is the government’s decision to sell its 26 per cent stake in the company in the current financial year through the offer for sale and strategic sale routes. Moreover, with the stock rising 350 per cent since the start of FY21, expectations were high resulting in a correction on a miss on the performance front.

While revenues fell 4 per cent, its operating profit declined 10 per cent on a sequential basis. While analysts expected some weakness due to seasonality, the fall was sharper than estimates — by 5-10 per cent. As compared to the year-ago period, revenue growth was flat and operating profit was up 37.5 per cent.

In addition to seasonality, the company highlighted deal conversions are taking longer due to Covid-19 and there has been a loss of revenues in certain segments. In the data business, especially the growth segment, the impact due to holidays was higher as it is largely usage-based.

The media and mobility businesses were affected by Covid. While in media, there has been some recovery due to the start of sporting events and travel, it is still lower than pre-covid levels. In the mobility space, the company has been affected by lower roaming, as well as lower usage in customer segments, such as airlines.

Delivery of order book was slower because of the imposition of lockdown in some countries in Europe. There was also some churn from customers due to the consolidation of offices and rationalisation of bandwidth. The company, however, indicated this was temporary and should pick up again. The imposition of higher interconnect usage charge by the regulator has also impacted its volumes in the enterprise voice segment. The ban on some of the Chinese over the top application players in India by the government also hit revenues as these players were Tcom’s customers.

However, despite the muted revenue performance in the quarter, the company indicated the demand outlook remains robust and the company expects recovery and acceleration in the coming quarters. This is expected to reflect in revenue growth as the deal pipeline and orders are executed. The company believes its suite of products and solutions will help capture the transition from private networks to a mix of internet and hybrid networks.

The company has been able to keep costs under control leading to sharp margins gains over the year-ago period. Margins were up 680 basis points YOY to 24.8 per cent on the back of profitable data business and cost efficiency initiatives, be it the optimal mix of Indian and global employees, postponement of certain expenses due to Covid-19 or sourcing rationationalisation.

There may be some pressure as part of the marketing and training costs reverse. There can be higher outgo on account of maintenance.

What’s positive is the robust free cash flows, which have helped bring down the net debt to ~7,972 crore, down ~659 crore over the September quarter. Net debt-to-operating profit is now under 2x, as compared to 2.9x a year ago.

For the stock to sustain gains, revenue growth has to improve and margin gains need to be sustained. At the current price, the stock is trading at 29x its FY22 earnings estimates; investors should await a consistent improvement in sequential revenue growth before considering the stock.