As India embarks on a new 5G-enabled digital transformation, a company that is ideally a key beneficiary of the trend has actually had a tough ride in the bourses. The stock of Indus Towers is down by 24 per cent in the last one year.

In our bl.portfolio edition dated February 20, 2022, we had recommended that investors accumulate  the stock on dips. At the time of the recommendation, the stock was trading at ₹253.  Our expectation then was that, given the global and domestic interest rate hike cycle we foresaw and brewing Russia-Ukraine crisis (war had not started then), the ensuing market volatility would result in decline in price of Indus Towers and provide attractive entry points in the stock for long-term investors. However, the correction of 38 per cent since is significantly more than what we had anticipated.

Analysing the reasons that caused the decline (explained below) and factoring the company’s current fundamentals, there are sufficient reasons to believe the long-term prospects of the company remain good. Hence, with the stock trading at a cheap one-year forward PE of 8.4 times and EV/EBITDA of 4.6 times, we now recommend a buy on the stock. Investors who got in earlier can also add to positions at current levels.

The key risk for the business prospects of Indus Towers is the Indian telecom market becoming a duopoly, if the revival of the two weak players in the market — Vodafone Idea and BSNL — does not succeed. The current valuation of Indus Towers is already reflecting this risk. Upside catalysts are revival of the weak telecom players and re-instatement of dividends.

Business

Indus Towers in its present form was formed by the merger of Bharti Infratel and erstwhile Indus Towers (which was a tower joint venture between Bharti Airtel, Vodafone and Idea) in 2020. Following the merger, Indus Towers is the largest telecom tower infrastructure provider in the country and one of the largest globally.

Its primary business is to acquire, build, own, operate and maintain tower and related infrastructure. Tower infrastructure refers to equipment such as towers, shelters, power regulation equipment, battery banks, diesel generator sets, etc, required at sites where towers are installed. This type of facility is also known as passive infrastructure in the telecom context. These facilities are utilised by wireless telecom service providers on a shared basis, under long-term contracts. Leasing external tower infrastructure frees valuable capital for telecom service providers to invest in their core operations and improveservice quality. All wireless telecom service providers in India are customers of Indus Towers.

With 1,92,874 towers and 3,42,831 co-locations (more than one entity utilising same tower), Indus Towers has nationwide presence, with operations in all 22 telecom circles.

Prospects for the company depend on a combination of increasing demand for towers as wireless telecom density increases as well as increasing utilisation of/co-locations in towers as newer and enhanced offerings like 5G drive demand. The company has indicated that telecom operators are significantly scaling up 5G rollout and the momentum is likely to continue for the next couple of years at least. Currently, incremental rental growth of 5-10 per cent is being realised from loading of 5G equipment in its existing towers.

Reason for underperformance

Prior to our accumulate call last year, Indus Towers (Bharti Infratel in its earlier form) had already corrected by 47 per cent from its peak price of ₹479 in 2015. Consolidation in the Indian telecom sector lowering tenancy ratios and thereby reducing growth and operating leverage were the key reasons. Much of this was factored into the price of the stock post the correction, including the uncertainty surrounding the revival of Vodafone Idea. However, a key negative trigger played out last year when Vodafone Idea was unable to pay its dues to Indus Towers in FY23. Consequently Indus Towers has booked a significant provision for doubtful debts of over ₹5,300 crore in FY23.

Thus, while revenues in FY23 grew marginally by 2.5 per cent to ₹28,381 crore, EBITDA declined significantly by 35 per cent for the year to ₹9,767 crore. EBITDA margins, which in a normal year trends closer to 55 per cent range, declined to 34 per cent. The larger hit came in the form of the company having to do away with dividends for the year due to this payment issue, which impacted free cash flows for the year.

A main attraction amongst investors to the stock stems from its stable dividends churned out every year. When this was in doubt, the stock took a hit. Globally, tower stocks are viewed as dividend plays. In fact, many listed tower companies, globally, have all been converted into REITs. This is due to their stable, sustainable and predictable business and financials. The uncertainty around Vodafone Idea has stressed this concept in the India.

On the mend

While FY23 was largely a washout, towards end of the year green shoots have been emerging. For 4Q FY23, Vodafone Idea had paid most of its current dues (while the past dues of over ₹5,000 crore are still under negotiation). The signals around capital raise in Vodafone Idea and revival of BSNL are also getting stronger. Progress on this and addressing past dues from Vodafone idea are key potential upside catalysts for the stock to monitor.

Further, the management has indicated that they are reviewing ability to pay dividends. Dividends are linked to free cash flows and this took a hit in 2023 due to issues mentioned above. With the issue largely one-off, it may just be a matter of time before dividends are re-instated and yield investors return to the stock. While there are uncertainties on extent of future dividends, past dividends can provide a perspective. For FY20, FY21 and FY 22 the company had paid dividend per share of ₹12.80, ₹17.82 and ₹11 respectively

In the meantime, the stock is not pricing in the scope for these upside catalysts, while the risks are adequately reflected at current levels. This makes risk versus reward quite favorable for patient investors. Leverage metrics are also strong, with interest coverage ratio in high single digits (excluding impact of one offs) and net debt/EBITDA below 2 times.

Another factor to note is the distressed valuation levels Indus Towers is trading at as compared to global counterparts. While Indus Towers trades at one-year forward EV/EBITDA of 4.6 times, US listed American Tower Corp, SBAC Communications Corp, and Crown Castle Inc trade at 18.7, 19.6, and 16.1 times respectively. Given the long-term growth potential as the sector stabilises and 5G trends accelerate, there is a strong case for valuation multiple expansion in Indus Towers.   

Why
Green shoots of turnaround emerging
Risks well factored at current levels
Multiple upside catalysts in the long term
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