Making a sound investment call
Published: 00:00 March 27, 2012
Etisalat’s current share price reflects the challenges faced by the UAE’s largest telecommunications company in the last few years.
Amid mounting pressure in its home market and difficulties overseas, the company’s stock has fallen 44 per cent since its almost three-year high of Dh16.70 in April 2008 — it was valued at Dh9.27 at the close on Thursday.
Etisalat is an anomaly on the UAE’s capital markets scene. It holds by far the largest weighting on the Abu Dhabi Securities Exchange (ADX), accounting for 27.51 per cent of the bourse’s market cap, but can only be held by UAE nationals.
It tends to have a large impact on how much the ADX moves from day to day but in recent times etisalat has not seemed a particularly good investment opportunity, and local traders have been withdrawing their money from the stock.
“Over the last five years, etisalat has struggled for growth. It has faced competition for the first time in the UAE, while its international operations, with the exception of Saudi Arabia, are yet to provide serious traction to the bottom line,” said Ebrahim Masood, senior investment officer at Mashreq Bank.
“This is reflected in a five-year compounded annual growth rate (CAGR) of 2.8 per cent in operating income, seven per cent in EBITDA (earnings before interest, taxes, depreciation and amortisation) and 14 per cent in revenues. Over the same time the return on equity (ROE) has declined from almost 34 per cent in 2007 to just 15 per cent last year,” he added.
Masoud says these figures underscore etisalat as a fairly mature telecom asset with muted growth prospects, adding the dividend yield of seven per cent plus is one of the only reasons to consider (investing in etisalat) under the present status quo. However, he also said etisalat was delivering these numbers after paying a stiff royalty of 50 per cent on operating income.
“This royalty, originally paid in return for monopoly status, may get modified at some future point. Currently only UAE Nationals can hold the stock, further limiting investor demand,” Masoud said.
“A change in both may result in a one time price adjustment; failing that, at 1.8 times price to book value with ROE declining below 20 per cent, the dividend yield alone is not a good enough reason to hold etisalat,” he added.
Etisalat, which operates in 17 countries, has seen its profit margins squeezed at home since the arrival of du. The UAE’s duopoly market remains one of the least competitive in the Arab world — the Telecommunications Regulatory Authority said earlier this year it has no plans to issue a third licence — but competition does exist and du has managed to eat substantially into etisalat’s local market share.
“Etisalat is still a dominant player on the UAE telecommunications market but it is losing the more price sensitive clients to du and facing stagnating revenues,” said Petr Molik, chief financial officer at Menacorp, an Abu Dhabi-based brokerage.
“Etisalat still shows excellent margins and cash generation but the biggest challenge for the company is to find future areas for revenue growth, either with acquisitions or better development of its subsidiaries outside of the UAE. Stable dividend payments should provide a good support for the stock price for a conservative investor,” he added.
It is not just domestic competiton, however, that has hit etisalat’s bottom line; the company has also been affected by troubles abroad, most notably in India. etisalat posted a 23.4 per cent slump in 2011 net profit last month after writing off the value of its Indian operations.
India’s Supreme Court ordered the government to revoke all 122 second generation (2G) licences issued in a 2008 sale at the centre of a major corruption scandal. Swan Telecom, which was later renamed etisalat DB after etisalat bought a stake in the firm, was one of eight companies that acquired the licences at cut-price rates.
“Generally speaking, second or third licenced operators are faring better than incumbents, as the latter tend to have various international positions, which makes them vulnerable to forex losses that have dented bottom lines over the last few years,” said Raghu Mandagolathur, senior vice president for research at the Kuwait Financial Centre, also known as Markaz.
Mandagolathur says etisalat’s revenue growth was minimal last year due to weak global economic recoveries. “The company took a 23 per cent hit to its bottom line in 2011 due to discontinued operations in India, but it has proposed a 60 fils per share dividend for the year, maintaining its dividend yield at about 6.5 per cent,” he said.
“Etisalat’s stock shed 15 per cent last year and is relatively flat so far in 2012, so there is potential for solid returns provided revenues start picking up during the year,” he added.
Both UAE telcos have also taken steps towards the deployment of high-speed fourth-generation (4G) long-term evolution (LTE) networks. But analysts believe the main challenge for etisalat in the next few years is striking a balance between achieving growth both in its home market and overseas.
“Etisalat continues to focus more on expanding its international operations, which has given du a window of opportunity to strengthen its presence in the UAE,” said Hasan Sandila, a telecommunications analyst at IDC Middle East Turkey and Africa.
“Going forward, etisalat should focus more on safeguarding its domestic market position as the UAE accounts for the majority of the company’s group revenues (66 per cent in first quarter 2011),” he added.
Du has enjoyed a remarkable few years since its arrival on the UAE’s telecommunications scene in 2007 but analysts have mixed views on whether the company’s stock represents a sound investment.
The company proposed its first ever dividend earlier this year despite seeing its full-year net profit hit by an increased royalty fee to the UAE federal government.
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Du’s stock, which carries a weighting of 7.08 per cent on the Dubai Financial Market (DFM) General Index, is currently trading at a price-to-book ratio of 2.25x. The company’s share price stood at Dh3.17 at the close on Thursday following a rollercoaster journey for the stock.
Analysts remain unconvinced that du represents a good investment opportunity amid concerns over how the company plans to maintain strong growth rates in the years ahead.
“Du is suffering somewhat from investors prematurely deciding its growth phase is over. We believe the potential and outlook for growth in data consumption is being seriously underestimated, and du still has some way to go before becoming a cash cow,” said Ebrahim Masoud, senior investment officer at Mashreq Bank.
“The operating performance of the company has been exceptional so far, and it has delivered that growth without significantly compromising the profitability of the UAE telephony market as ARPU [average revenue per user] still remains fairly high. With most of the capital expenditures [capex] taken care of, the company expects to spend about Dh1.2 billion next year, flat year on year,” he added.
According to Masoud, stabilisation of capital expenditures, combined with strong cash generation, will lead to du proposing rising dividends in the years ahead. Du surprised the market by announcing its maiden dividend one year before expectations, and the current yield stands at 4.8 per cent.
“Trailing price-to-earnings for du is less than 13, the dividend yield is close to five per cent. It is a core buy idea for investors not only in the UAE, but for those looking at the broader Mena region. Du’s focus on the UAE alone, makes it a good proxy for the recovering growth rates in Dubai, and ongoing strength in Abu Dhabi,” Masoud said.
Du’s 2011 net profit before royalty grew by 47.8 per cent to Dh1.8 billion in 2011, leading the company to propose a dividend of 15 fils per share.
However, du also had to take into account the Government’s new royalty structure, which will see the company pay over 15 per cent of its 2011 net profit, along with a further five per cent of revenues. Du will make the Dh715 million payment in 12 monthly instalments starting next month. The telco paid royalties of Dh184 million in 2010.
“In terms of the number of mobile connections, du has surpassed five million customers, which represents approximately 46 per cent of the UAE’s market share,” said Hasan Sandila, a telecommunications analyst at IDC Middle East Turkey and Africa. “Du’s performance is in line with market expectations given the company has constantly outperformed the UAE market in recent times,” he added.
Sandila says du’s strong performance can be attributed to its wide array of offerings in the mobile domain, adding the company’s unique selling proposition remains its per second billing scheme.
“The consistent increase in du’s popularity is not just because it represents alternative competition to etisalat but also because du has been very effective in launching innovative products and service initiatives,” Sandila said.
“Initially, du was mostly popular among the pre-paid segment but due to its continued efforts to enhance customer service, it has now gained significant popularity among the high-value postpaid customers,” he added.
Du said earlier this month it expects to spend around Dh1.2 billion in 2012 but has no immediate plans to expand beyond its home market. The company said earlier this month it still had value to offer the UAE including the roll-out of its high-speed, fourth-generation (4G) long-term evolution (LTE) network.
Some analysts believe du’s lack of overseas activity can be taken as a positive, arguing the tactic could actually contribute to better investment returns.
“Du has a lot going for it in terms of not having exposure to foreign markets, and consequently not being exposed to forex fluctuations especially once mobile number portability comes into effect,” said Raghu Mandagolathur, senior vice-president for research at the Kuwait Financial Centre, also known as Markaz.
“It will provide more growth opportunities for the firm in terms of its ability to grab market share from etisalat. Du’s stock was down 2.7 per cent in 2011, giving it room for returns,” he added.
Du’s free cash flow reached Dh1.4 billion last year, up from Dh36 million in 2010 and in the fourth quarter, the company added 278,100 mobile customers, bringing du’s total mobile customer base to 5.2 million.
“Du is a well run company with a clear strategy, excellent brand recognition and quality products offered in both fixed and mobile communications,” said Petr Molik, chief financial officer at Menacorp, an Abu Dhabi-based brokerage.
“With limited potential for future growth in revenues, du must concentrate on increasing its margins that are significantly below etisalat’s. Despite good business prospects, we predict only a moderate growth in stock price given the market situation and challenges to increase its margins,” he added.
- Revenues – Dh32.2 billion
- 2011 Net Profit (after royalty) – Dh5.8 billion
- Total mobile customer base (As of Dec 31, 2011) – 7.8 million
- 2011 dividend – 60 fils per share
- Current share price – Dh9.27
- Revenues – Dh8.9 billion
- 2011 Net Profit (after royalty) – Dh1.1 billion
- Total mobile customer base (As of Dec 31, 2011) – 5.2 million
- 2011 dividend – 15 fils per share
- Current share price – Dh3.17