At bl.portfolio, we  had held a positive view on Bharti Airtel (Airtel) for the last three years, since our buy recommendation in our edition dated April 11, 2021, when the stock was trading  at ₹533. In our follow-up updates too during this period, we had recommended that investors continue to accumulate/hold the shares, given favourable company-specific and industry factors at play.

However, we are now shifting to a cautious stance on the stock, purely on valuation. From a valuation perspective, the one-year forward EV/EBITDA for Bharti Airtel has expanded from 8 times in April 2021, to 10.6 times as against the five-year average valuation of around 8.9 times. Stretching beyond this multiple may be challenge for telecom stocks, except when in the midst of a turnaround.

Globally, large telecom players trade in the range of 4-7 times EV/EBITDA, with few exceptions such as Indian telecom companies and T-Mobile USA trading at a premium to this range. While this premium can sustain, it may not expand much from here, with risks tilted to the downside.

 In the last three years, the stock has benefitted from two main factors – one, a positive reset in business post Jio and AGR-related disruptions, with Airtel emerging stronger from the crisis in the sector. In this period, Airtel has delivered strong EBITDA growth driven by market share gains, increase in tariffs, increasing share of 4G subscribers in customer base, and also by continuing to execute well (something it has done consistently over the last 25 years). The company’s balance sheet has also strengthened substantially in this period as better growth resulted in higher free cash flows, resulting in net debt/EBITDA at a comfortable 2.9 times now .

Two, as the company delivered better overall performance, investors have also rewarded it with multiple expansion as can be seen in the increase in EV/EBITDA multiple over the last three years. The two factors together have resulted in the stock moving up by 145 per cent since April 2021 as against Nifty 50’s near 50 per cent gain.

With the stock trading at the upper end of historical valuation range and growth for next few years also likely to taper versus recent years, the stock appears to have priced in all the positives, including growth from 5G and scope for tariff increases, post elections. Market share gains may also face some brick walls post Vodafone Idea’s successful rights issue.

Hence, we recommend that investors book partial profits and lock in on the gains. We are not recommending a complete book profit due to the fact that Bharti Airtel can remain a core holding in a long-term portfolio, given its size, scale and good execution track record.

Business

At a consolidated level, Airtel is the largest telecom player based out of India, with operations in India (69 per cent of revenue), Africa (30 per cent) and South Asia (1 per cent). Its business encompasses mobile services (around 80 per cent of revenue), enterprise/business services (enterprise connectivity, submarine cables; around 14 per cent of revenue) and other services such as DigitalTV/DTH, home services, etc.

India mobile services is the largest segment and the key driver for business and shares.. It accounts for 54/57 per cent of consolidated revenue/EBITDA respectively. It currently has around 33 per cent of the mobile subscriber market share in India vs Jio’s 39 per cent. As compared to two years back, Airtel has gained much of the ground ceded by Vodafone Idea, with market share increasing from 30 per cent, while Jio increased its market share by 1 per cent in the same period.

Performance

The turnaround in the business of Airtel, which underlies the outperformance in shares, can be best understood by comparing its performance over the last five years with the five-year period prior to that. The FY19-24 revenue and EBITDA CAGR for Airtel (includes consensus estimates for Q4FY24) is at 13 and 25 per cent respectively. As compared to this, the five-year period of FY14-19 was one of painful readjustment to disruptions in the industry and the period revenue and EBITDA CAGR were at negative 1 per cent.

Post this turnaround, the company, while it is expected to deliver decent growth, is unlikely to repeat the growth witnessed in FY19-24, over the next five years. Consensus estimates based on expectations of tariff increases sometime in FY25 indicate growth of 12 per cent in revenue and 26 per cent in EBITDA.

This appears quite optimistic for two reasons. One, since market share gains may taper or stall from here, revenue will have to be primarily driven by ARPU growth and other business segments.  Two,  given the fact that EBITDA margins are at all-time highs at 52.7 per cent, incremental margin gains will be more challenging. Hence EBITDA growth significantly  higher than revenue growth may be arduous. Nevertheless, at 10.6 times one-year forward EV/EBITDA, this optimistic expectation is already factored, leaving a low margin of safety at current levels.

The 5G story is ahead for Airtel. However, the theme will take a few years to play out as it will require support from the ecosystem as well to make the experience productive and meaningful. Cheaper 5G smartphones and development of other 5G use case devices are essential for the theme to gain traction.

While existing investors can book partial profits, new investors can wait for more clarity on 5G theme picking up and better entry points.

Why
Multiple expansion has played out
Low margin of safety
5G unlikely to be a near-term driver
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