Bharti Airtel: 5 reasons why this brokerage has downgraded this stock to underperform

Telecom major Bharti Airtel outperformed in 2022, up 18 percent as against a 4 percent rise in benchmark Nifty on the back of its defensive characteristics, sustained market-share gain, and stabilizing competitive environment.

However, after a positive 2022, brokerage house BofA Securities has now downgraded the stock to 'underperform' from 'neutral' earlier as it finds Airtel's risk-reward unfavourable. It has also cut its target price by a massive 22 percent to ₹700 from ₹895 earlier. The new target implies a downside of 8.5 percent for the stock.

“We consider Bharti Airtel’s valuation as rich and see a limited margin of safety. Inflation and INR-depreciation headwinds could impact demand and lead to higher capex/interest payments going ahead,” it said.

It also cut FY24/25E EPS to ₹26.8/34.1 on slower-than-expected net adds and lower margins and higher interest expenses. Its FY24/25E EBITDA is at 3-6 percent and net income is 14-21 percent (on a low base) below consensus.

Bharti Airtel is one of India's top 3 telecom operators. Apart from providing mobile services in India (2G, 3G and 4G), the company also provides DSL (digital service line), DTH (direct to home) and enterprise services. Bharti is also present in around 14 countries in Africa and in Sri Lanka and Bangladesh.

While Airtel has historically traded at a premium to the Asian telecom majors, the brokerage believes, in the context of changing dynamics, the gap could narrow. Bharti trades at 9.5X FY23 proportionate EV/EBITDA vs Asian telco avg of 6.6X and sees a limited margin of safety, said BofA. It added that the consensus is building high expectations on tariff increases, which can be postponed due to general elections. It also believes Airtel's competition may increase with Jio getting aggressive in the postpaid market and the possible entry of Adani in 5G/B2C apps. Organic subs addition may slow down, added BofA.

Let's take a look at the 5 reasons behind this downgrade:

1) Tariff hike expectations high: As per the brokerage, the consensus is already factoring in an ARPU (average revenue per user) hike of over 10 percent in FY23E and 11 percent/9 percent for FY24/25E. Furthermore, with general elections scheduled for 2024, it sees risks of the next round of tariff hikes being pushed back to post-elections. This would likely lead to downside risks to consensus, said BofA.

2) Rich valuations; low margin of safety: Bharti is trading at 9.5X FY23 prop. EBITDA vs Asian telcos’ average of 6.6X. While it historically traded at a premium to Asian telcos, BofA believes, in the context of changing dynamics, the gap could narrow. It considers Bharti’s valuation as rich and sees a limited margin of safety. Inflation and rupee-depreciation headwinds could impact demand and lead to higher capex/interest payments going ahead, noted the brokerage.

3) Competition at a margin may increase: One of the reasons Bharti traded at a premium was low competition, with India largely being a 2.5-player market. Going ahead, BofA sees risks of competition intensifying. This is on the back of Jio getting aggressive in the postpaid market (Bharti’s stronghold) and Bharti improving its footprint in tier-3/4 cities (Jio’s stronghold). Competition could be more pronounced to poach competitors’ subs as organic net additions slow down, it noted.

4) Adani getting more aggressive: India has largely been a duopoly in the telcos space over the last few years, with Jio and Bharti gaining a share at the expense of VIL and Bharat Sanchar Nigam Limited (BSNL). Going ahead, it sees risks of Adani Group looking to get more aggressive in the telcos space. Adani bought 5G spectrum in the 2022 auction, suited more for enterprise offerings, however, in Oct 2022, it received a unified license allowing it in theory to target the B2C market as well. According to media articles, Adani is planning to roll out enterprise 5G services and consumer apps this year. Any potential unexpected move by Adani in the B2C space may not impact Bharti and Jio for the next few years but could lead to multiples de-rating with a well-capitalized new player entering the space, predicted the brokerage.

5) Risks of 700 MHz bidding; higher-than-expected capex: Currently, Jio has a 700 MHz spectrum and Bharti does not. While the brokerage said it does not see this leading to any material disadvantage to Bharti in the near term, as by having uplink and downlink on different spectrums Bharti could still offer good service and partly mitigate the in-building coverage disadvantage. However, with increasing 5G traffic, the need for a low-band spectrum that could also provide capacity would increase, it noted. Hence, BofA expects Bharti to eventually buy 700 MHz. This could lead to an over $5 billion payment, as well as more capex to focus on a Standalone (SA) rollout in the medium term.

Key events to watch out for in 2023 that may lead to risks: 1) faster-than-expected 5G rollout – may disappoint in 5G; 2) any potential auction where Bharti may participate in 700 MHz; and 3) slowing smartphone, cautioned BofA.

However, i) Bharti will gain share from VIL and gain from any sector benefits from the govt; ii) enterprise and broadband momentum would be strong, and iii) news flow on potential IPOs of subsidiaries may pick, it added.

In Q2, the company's consolidated net profit for Q2FY23 rose 89 percent to ₹2,145.2 crore against ₹1,134 crore reported a year back, thanks to strong growth in data traffic. Its total revenue stood at ₹34,526.8 crore, up 22 percent from ₹28,326.4 crore reported in the corresponding quarter last year.

On a consolidated basis, which includes numbers from its operations in 16 countries, its voice traffic grew 5.1 percent while data traffic jumped 20.9 percent. The customer base was at 50.1 crore across 16 countries, up 4.8 percent YoY.

Consolidated EBITDA was at ₹17,721.2 crore during the quarter, up 26.4 percent YoY and 6.7 percent QoQ. EBITDA margin for the quarter was at 51.3 percent as compared to 49.5 percent in the corresponding quarter last year and 50.6 percent in the previous quarter.

Disclaimer: The views and recommendations made above are those of individual analysts or broking companies, and not of MintGenie.