Telecom stocks seem to have suddenly fallen out of favour with investors. Bharti Airtel Ltd and Idea Cellular Ltd’s stocks have fallen by 7% and 8%, respectively, in the past three trading sessions, while the broader markets have been flat during the same period. But note that this is on the back of a period of massive outperformance. In the year until 3 October, i.e. before the recent correction, shares of Bharti and Idea had risen by 6% and 36%, respectively, despite a 21% drop in the broader markets. So the recent correction could well be a case of tempering of heightened expectations.

Also See | Tempered Optimism (PDF)

But why are these stocks correcting now? To start with, there has been a recent earnings downgrade by Goldman Sachs Group Inc. as well as a report by Kotak Institutional Equities stating that the September quarter earnings will be weak. Analysts at Goldman say that Bharti is likely to miss the Street estimates for the sixth straight quarter. This could lead to a derating of the stock. Idea, which has done exceptionally well in the past few quarters, could face a setback owing to higher interest costs as well as lower margins. According to Kotak’s estimates, the company’s pre-tax profit is likely to drop 30% sequentially. While much of this is owing to a higher depreciation charge and higher interest burden, owing to the full capitalization of 3G expenses, even operating profit is expected to be flat owing to a drop in margins.

Telecom companies have typically reported relatively softer numbers in the September quarter as the monsoon affects volumes. But this time around, companies have to deal with additional interest and depreciation charges, as well as steep forex-related losses owing to the depreciation in the rupee last quarter.

Valuations of telecom companies had risen sharply in the past one year because of the decline in competitive intensity, which eventually even resulted in companies hiking tariffs in select circles. The impact of this is not likely to be visible yet in the results. In any case, the markets seem to have overestimated the impact of this on companies’ financials. After all, it is yet to be seen if the move will affect usage and volumes.

Some of the weaknesses in telecom shares of late could also be because of the apprehension about the new telecom policy of the government, which will be unveiled on Monday. If telecom companies have to pay a one-time fee for the additional spectrum they hold, for instance, it will prove to be quite a blow. The good thing is that all of the above events have brought a much-needed check on the valuations of telecom stocks.