Reliance Communications Ltd (R-Com) was the top gainer among Nifty stocks on Thursday. Even though the Nifty fell by 1.2%, R-Com shares rose by about 3.5%, thanks to an upgrade by Citigroup Research. The broker now has a “buy” rating on the stock, against a “sell” earlier. The firm’s stock has risen by about 24% from its lows in late February, at a time when the Nifty has risen by about 3.5%.
In this backdrop, a pertinent question is if the worst is over for the stock. That would be a hasty conclusion. Consider Citi’s report itself. While the broker has recommended a “buy”, it has also cut its target price by about 18%. The core telecom business has been valued at an EV (enterprise value)/Ebitda (earnings before interest, tax, depreciation and amortization) multiple of 6.3 times based on earnings estimates for 2011-12 (FY12). This represents a 25% discount compared with the valuation ascribed by the broker for bigger rival Bharti Airtel Ltd. The discount has been raised from 20% earlier. What’s more, earnings estimates have also been cut. At the Ebitda level, estimates have been cut by 6% and 7%, respectively, for FY12 and FY13, and at the net profit level, they have been cut by as much as 33% and 26%.
Also See Losing Value (PDF)
The value of the tower business has also been reduced sharply to Rs25 per share, because of “low visibility on external tenancy especially as Etisalat DB (signed up for bulk tenancy) is currently embroiled in the 2G (second-generation) spectrum controversy and is unlikely to undertake additional green-field roll-outs”.
While Citi has cut its target price for the above reasons, it so happens that R-Com shares had fallen to even lower levels in the market correction, thanks primarily to concerns regarding the firm’s involvement in the 2G scam. The stock had more than halved between November and February to Rs85-90 levels. Also, Citi’s estimates of R-Com’s replacement cost are at Rs120 per share, making it an “attractive acquisition opportunity”.
The above factors have prompted Citi’s “buy” rating, rather than any visible change in the firm’s fundamentals. In fact, as the report points out, R-Com’s business momentum has been lacklustre owing to low utilization of its GSM network (vis-à-vis larger peers), besides the fact that mobile number portability has hurt the company in both the GSM and CDMA segments. So while R-Com shares are returning to more reasonable levels, the rally may not sustain.
Graphic by Naveen Kumar Saini/Mint
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