NCB Capital, the GCC’s leading wealth manager and the Kingdom’s largest asset manager, believes that given the recent volatility in the stock market, valuations look attractive with the Telecom sector trading at a 2012e P/E of 8.0X.
In its latest report, NCB Capital maintained its cautiously optimistic view on the Saudi Telecom Sector and reiterated its Overweight rating on STC with a PT of SR51.2 (upside of 30%) and Mobily with a PT of SR78.7 (upside of 25%), and upgraded its rating on Zain KSA to Neutral with a PT of SR8.3 (upside of 6%).
“Our price targets for STC and Mobily have increased by 2% and 4%, respectively, based largely on strong 1Q12 results, as well as an upward revision in our estimates,” said Farouk Miah, Head of Equity Research at NCB Capital. “For STC, this was led by improved local and international operations, while Mobily benefited from good revenue growth and improved operational efficiencies. Despite a weak 1Q12, our PT for Zain increases by 18% due to improved outlook expected in outer years off the back of stability in its ARPU.”
This PT does not factor in the balance sheet restructuring for which the EGM has been delayed to 4 July 2012. Successful restructuring is expected to result in improved financials (due to lower financial charges) and lift the company’s valuation multiple.
According to the report, the main concern for the sector is price-led competition, especially in the international calls segment which held-back overall margins in 2011. NCB Capital believes the telecom operators realize that price-led competition does more harm than good, and thus expect some stability in margins this year, as observed in 1Q12.
“We continue to believe that the sector has good growth potential, particularly broadband. Profits should be driven by higher focus on value-added services (broadband) and benefits derived from international exposure (STC),” added Mr. Miah.
Due to the recent volatility in the stock market, the telecom sector is down 6% in the past month. Much of this sell-off is unwarranted given the robust 1Q12 performance, strong dividend yield and good outlook. At 8.0x 2012e P/E, the sector trades 8% below regional peers, despite the relatively stronger macro environment in Saudi Arabia vs. other regional countries.
Total revenue for the three stocks under NCBC’s coverage is expected to increase 9.4% YoY to SR90.2bn in 2012 driven by a higher broadband subscriber base and growth in the Saudi corporate segment. NCB Capital believes STC should continue positive domestic and international growth. As data and broadband continue to grow in Saudi Arabia, Mobily should keep benefiting from its scale of network. For Zain, a slowdown in subscribers should be more than offset by higher ARPU following the removal of inactive SIM cards.
According to data from CITC, mobile penetration in Saudi Arabia grew just 2% YoY to 188% at the end of 2011 compared to NCBC’s estimate of 202%. “This is largely due to cancellation of inactive subscribers as Zain decided to fully comply with CITC’s “active subscriber” ruling in 4Q11. NCB Capital estimates penetration to reach 194% in 2012, excluding further SIM cancellations. However, with the penetration rate nearly 200%, we believe operators are focusing more on deriving value from existing customers rather than acquiring new subscribers,” highlighted Mr. Miah.
According to the latest information from CITC, the broadband penetration rate for data services reached 39.7% of the population, or 11.34mn users, at the end of 2011. The number of fixed broadband users increased to 1.95mn in 2011 from 1.74mn in 2010, implying a household penetration rate of 33% compared to 27% a year earlier. For Mobily, 22% of revenues came from data in 2011 compared to a 9% in 2008. STC claims it has 52% of all broadband subscribers in Saudi Arabia. Interestingly, wireless broadband users are largely responsible for the recent growth in overall broadband users, accounting for 85% of the total compared to 48% in 2009. Furthermore, given the introduction of mid- and low-end smart phones and the improved technical capability enabling the use of richer media content, NCB Capital believes this segment would continue to expand over the coming years and support top-line growth for the sector.
NCB Capital believes Zain’s decision to cancel all inactive SIMs in 4Q11 lifted the overall ARPU for the sector during the quarter. This coupled with growing revenue from data services and increasing percentage of post-paid subscribers (where ARPU is significantly higher compared to pre-paid) should stabilize ARPU in 2012. Accordingly to Mobily’s management, 12% of its subscribers are currently post-paid, and this is likely to increase in the coming years. For STC, around 25% of subscribers are post-paid. However, NCB Capital believes price-based competition will continue to exert pressure on prices and offset the gains in ARPU from data and post-paid subscribers.
Margin progress in 2012 for all three telecom operators under coverage will be dependant on access charge and OpEx changes in 2012. For STC, the key aim is to stabilize margins in 2012 after several years of decline due to competition and foreign investments. Mobily continues to look at OpEx gains to support margins. For Zain, with the ongoing capital restructuring, we expect overall operational performance to improve, with lower debt to reduce financial charges. Furthermore, NCB Capital believes access charge is the main cost element that held back margins in 2011. However, with reduced competition in the international calls segment, access charge for STC and Mobily declined in 1Q12. This trend is expected to continue.
NCB Capital’s 2012 EBITDA and net margin for STC and Mobily have both increased marginally led by lower-than-expected access and operating expenses in 1Q12. For Zain, although EBITDA and net margin improved on YoY basis, the figures came in lower than expected. In line with this, NCB Capital has reduced its margin estimate for the company. “Nevertheless, we wish to highlight that our margin estimate will likely improve significantly in the outer years as we incorporate the capital restructuring at Zain after approval,” explained Mr. Miah.
Over the past one month, the Saudi telecom sector has fallen 6% with STC, Mobily and Zain down 2%, 5% and 13%, respectively. NCB Capital believes this was mainly due to the decline in the broader market amid ongoing concerns over the global economy. “In our view, much of this sell-off is unwarranted as telecom stocks in KSA are domestically driven and thus fundamentals should not be impacted. Additionally, 1Q12 results for the sector as a whole were robust. Hence, at a 2012e P/E of 9.4x, we believe the sector remains attractive with STC at 8.6x and Mobily 7.3x,” concluded Mr. Miah.
NCB Capital remains Overweight on STC with PT increasing by 2% to SR51.2. The company’s dominance in DSL and ability to provide bundles should support the top line, while progress in international operations is vital for bottom-line growth. Price-led domestic competition is the key risk to the stock. NCB Capital believes the current stock price offers an attractive investment proposition.
NCB Capital remains Overweight on Mobily with a PT of SR78.7. The company’s core business remains strong, largely led by broadband, with growth in the business segment an added benefit. An expected dividend yield of 7% by 2013 is another key strength and should limit any downside pressure on the stock.
NCB Capital upgraded Zain KSA to Neutral given the 30% fall in its share price since the last update in March 2012. The successful completion of its balance sheet restructuring, with the EGM set for July 04, should result in improved financials, higher book value and lower financial charges. However, competition remains high and further progress is critical for Zain to turn profitable.