Business | Telecoms

Du: Difficult decisions lie ahead

Du: Difficult decisions lie ahead

  • By Gaurav Ghose Financial Features Editor
  • Published: 21:42 November 25, 2012
  • Gulf News

The Emirates Integrated Telecommunications Company, du, is ringing up solid numbers with consumers and for its shareholders.

In the third quarter, the UAE telecommunications company added 227000 mobile subscribers, taking its customers up to 5.96 million. Revenue jumped 12.9 per cent to Dh2.52 billion over the same period last year and 2.8 per cent over the previous quarter. Du currently has 47.2% of the UAE market and has, over the past three years, been giving etisalat stiff competition.

The stock has surged 31.34 per cent in 2012 and in the last 12 months has risen 39.64 per cent. It closed at Dh3.80 last Wednesday. Some analysts believe that while the share is good value, there is very little room for left for further growth .

Financial Health:

Even though third quarter earnings fell four per cent below Security and Investment Companty (Bahrain) expectations, their senior analyst, research, Nishit Lakhotia believes margins will improve in the coming years. In a note after du’s third quarter results were announced he wrote: “We expect du’s earnings before Interest, taxes, depreciation and amortization( EBITDA) will continue to improve; led by operational efficiencies and growth in post-paid and data segments.”

Petr Molik, Group CFO and Head of Financial Advisory at MenaCorp, also expects du to post an EBITDA margins of close to 40 per cent, because of earnings growth and improving operational efficiency.

However, the third consecutive quarter of decreasing ARPU (Average Revenue Per User) is the biggest disappointment from the published figures, Molik wrote in his note after the results were announced, at the end of October. The current ARPU of Dh110 declined from AED112 in the previous quarter. He expects ARPU to bounce back in the fourth quarter but the “decreasing trend is worrisome,” he said. “Du may be under the same pressure as Etisalat with clients substituting some lucrative high margin (international) calls with cheaper alternatives (VoIP),” Molik said.

Overall, Molik believes the company’s finances to be healthy. He told Gulf News: “Du also has an excellent balance sheet thanks to reasonable capital expenditures, good cash flow generation and Dh1.0bn capital increase in 2010. The company is in a net cash position, with Dh1.96bn debt more than offset by Dh2.48bn of cash equivalents. Despite being much smaller than etisalat, du is fully able to finance all of its investments from cash-flows generated or make a reasonable size acquisition in the future.”

But, Mokik warned: “The challenge for du will come, when it reaches its limits of growth on the UAE market and will have to make a strategic choice to remain a one market operation, become a part of a multinational network or expand on other markets.”

Valuation:

The stock currently trades on a price earnings ratio of 12.8x (based on 2012 estimated earnings) and which is certainly favourable for the stock of a still growing company, said Molik. The sector’s P/E is around 10x, which means it is trading at 25 per cent premium.

“Du deserves the premium because the margins are expanding and it is growing,” said Lakhotia. “Overall, you have seen a very healthy growth over the last three to four years.”

Other financial ratios, including return on equity (ROE) and dividend payout, also point to the stock’s strength. The company paid cash dividends in 2012 for the first time, generating an average yield of five per cent. However, the company offered 1-for-7 rights issue in 2010.

“Du enjoys a high prospective ROE of above 20 per cent, while gross margin remains between 65 and 70 per cent,” said Talal Touqan, head of research at Al Ramz Securities, Abu Dhabi. “As of Q3 2012, the current ratio of the company remains relatively low, around 1. The company’s long-term debt to equity ratio dropped to 25.2 per cent.”

He also pointed out that Du paid out Dh0.15 earlier this year as cash dividend from 2011’s profits. This indicates a payout ratio of 62.5%. If the company decides to maintain the same payout ratio, the company may be able to distribute Dh0.20 next year. However, this remains uncertain due to the lack of history in paying cash dividends.”

Molik said in his note: “An increase in dividend almost certain. We believe that the company could increase its dividend to Dh0.20 per share next year. This represents a 5.6 per cent dividend yield at our target price of AED3.60 per share.”

Lakhotia expects du to take a couple of years before it becomes a dividend stock. “We have to remember that du has just recently started paying dividends,” he told Gulf News. “They still have one or two years to become a pure dividend play. Their dividend will increase in 2013 and 2014. Right now du offers a mix of a reasonable dividend of five per cent, which is not bad, and some growth opportunity as well.” Touqan added: “Since the beginning of 2009 to date, du’s stock gained 98.3 per cent, [while the Dubai index] remained almost flat. However, to have a clearer picture, the MSCI emerging market Telecom Index grew during the same period by almost 37.1%.”

Risk versus reward:

Touqan said that: “Generally, the 260-day volatility of the du stock, measured by annualized standard deviation, is estimated at around 25.9 per cent, compared to 17.4 per cent for Dubai’s general index. But, du would most probably have a relatively lower risk-to-return ratio.”

The final call:

Both MenaCorp and SICO have a hold rating on the stock.

Petr Molik, Group CFO and Head of Financial Advisory at MenaCorp has a AED3.60 per share target price. But, he said: “It would not surprise me if the market pushed the stock above Dh4.00, especially if the operator reports a great fourth quarter results. The stock [has exceeded] my expectations from six months ago and I’m ready to revise my target price after the full year results, as the management promised to outline its future plans [then]. We estimate that the dividend on 2012 results payable in 2013 could increase from Dh0.15 to Dh0.20 per share, implying a dividend yield of 5.2 per cent based on today’s price.” He added that there was high potential for another dividend increase next year.

Nishit Lakhotia, senior analyst, research at SICO, Bahrain, has a Dh3.90 target price for the share. “I [am] basically telling our clients to not take any action. We don’t see any major downside from these levels and at the same time the upside seems to be capped, unless there is a significant event.”

There could be a boost for the stock in the fourth quarter, in the form of a lower than expected royalty charge. The company has provisioned 50 per cent of its net profit for royalty charges, but lower payments —such as 15 per cent in 2010 and 39 per cent in 2011—is likely to improve their fourth quarter earnings and that could be the upside for the stock, said Lakhotia.

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