Stock Review: Bharti Airtel

 

 

Since the beginning of July Bharti's stock price has gained a smart 21 per cent. The icing on the cake for the stock was the out-performer rating assigned by Credit Suisse, which cited an improved competitive environment as the reason for its rating.

 

Many analysts had downgraded Bharti for having paid, what was in their opinion, a very high price for Zain. However, the stock had begun to slide much earlier when the tariff war in the pre-paid segment began. The failed merger with MTN and the consequent over-payment (in analysts' opinion) for Zain's assets in Africa added to the stock's woes.

 

Worst is behind it

The price war within the telecom sector appears to be petering out now. For the past eight months or so no player has initiated major price cuts. Moreover, both Bharti's management and analysts are of the view that since each operator has been allotted 20 MHz of 2G spectrum and 10 MHz of 3G spectrum, the scarcity of spectrum will prevent the government from allowing new operators, thereby limiting competition.

 

Furthermore, the Street is of the opinion that Bharti over-paid for Zain by $2 billion or around `25 per share. From the start of October 2009 to the end of June 2010, the stock shed 37 per cent of its price, or over `150 compared to its peak of September 2009. Hence, analysts are now of the view that the risk arising from the purchase of Zain has been factored into the current price.

The uncertainty surrounding the deal's funding has also been cleared. BAL has borrowed $9 billion from an 11-bank syndicate for six years at 195 basis points above the 3-month LIBOR. That translates into a net cost of debt of 2.48 per cent, which will translate into a $200 million interest outgo every year. The company's debt to equity ratio is currently at 1.21 while its net debt to EBITDA has increased to 2.8. Morgan Stanley estimates that the company's net debt to EBITDA ratio will halve over the next two years on account of positive free cash flow from next year.

 

Institutions' favourite

 

Mutual funds have been buying the stock since March, when its price hovered at historic lows. Till the end of June 2010, they had bought 1.78 crore shares worth around `490 crore. It was the most bought stock in the large-cap space in June 2010 when mutual funds made purchases worth approximately `296 crore. Besides mutual funds, other domestic institutions have also bought this stock. The result of all these purchases has been that domestic financial institutions' shareholding in the company has increased from 7.93 per cent (March 2010) to 8.83 per cent (June 2010). Incidentally Singapore Telecommunications also thought this was the opportune time to buy BAL's stock. It bought 0.04 per cent of BAL's equity from the open market. More purchases could occur in future since it has its board's approval to hike its stake to up to 1.52 per cent by November 2010.

 

What should you do?

The stock is trading at around `320 with a 12-month trailing PE of 12.93. This is much lower than its five-year median PE of 22.05. The PEG ratio of 0.25 is also attractive. Though valuation-wise the stock appears tempting, be aware of the risks. The second phase of tariff wars could commence soon in the post-paid segment once number portability is ushered in. The risk associated with managing vast networks in Africa and making them profitable remains. The price at which its competitor Singtel deemed the stock to be a good buy (around the `265 level) could be taken as a cue by retail investors as well