Investors seem to have either closed their eyes to the regulatory risks faced by Idea Cellular Ltd, or are betting that the company will come out unscathed from investigations into the allocation of the second-generation (2G) telecom spectrum. Despite the fact that the company’s name has appeared in government’s investigations, its shares have outperformed the market by a large margin of late. In the past one year, Idea’s stock has jumped 37%, while the Nifty has risen by only 6%.

For now, investors seem to be focusing on the company’s strong volume growth in the past fiscal. Volumes, or the total number of minutes carried on Idea’s network, grew 9% sequentially in the March quarter and nearly 40% on a year-on-year basis. In the past two quarters, the company has beaten Bharti Airtel Ltd and some other large operators in terms of revenue growth, and has also led in terms of growth in the revenue market share.

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In the first two quarters of the previous fiscal, the growth in volumes didn’t translate into earnings growth, as average tariffs fell at a relatively faster pace. But in the December and March quarters, earnings growth has tracked revenue growth.

In the March quarter, reported earnings before interest, tax, depreciation and amortization of the telecom business (excluding the tower business) rose 15.5% sequentially, much higher than the 7% rise in revenue. But reported margins increased due to the reversal of certain provisions made in previous quarters. Adjusted for these, margins were flat and earnings growth tracked the rise in revenue. Even so, the fact that earnings have risen 8% and 7%, respectively, in the preceding two quarters is a healthy trend.

In comparison, Airtel’s mobile services business has grown profit at an average rate of 1% in the December and March quarters.

Besides, incumbent operators such as Idea, Airtel and Vodafone Essar Ltd are doing relatively better in the current environment. New players, including Uninor and Tata DoCoMo, have become less aggressive and Reliance Communications Ltd seems to be hamstrung because of its high leverage.

While Idea’s shares may be benefiting from these trends, investors shouldn’t ignore regulatory risks. Apart from 2G investigations, the matter regarding the pricing of spectrum issued to incumbent operators in the past is still unresolved. According to Kotak Institutional Equities, the fact that Idea trades at a premium to Airtel despite facing higher regulatory risks leaves little upside potential for the stock.

Graphic by Yogesh Kumar/Mint

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