Telecom margins ‘hit by pricing race’

Growth in the Saudi telecom sector sector is mainly focused on broadband and corporate segments, according to analysts. The outlook on broadband remains strong with lower cost handsets expected to increase penetration rates, NCB Capital says in its latest report analyzing the Saudi telecom sector. NCB Capital, the GCC’s major wealth manager and the Kingdom’s largest asset manager, notes that growth in the sector is mainly focused on the broadband and corporate segments. While pricing competition remains high and margins could be pressured as a result, valuations remain attractive with the sector trading at 8.6x 2013E P/E. NCB Capital continues to be Overweight on STC, with a PT of SR 50.8 (upside of 19 percent), and Mobily with a PT of SR 88.6 (upside of 17 percent), while remaining Neutral on Zain KSA, with a PT of SR 8.4 (upside of 5 percent). “Although the outlook for Saudi Telecom Company (STC) and Mobily remains positive, we prefer the latter due to strong fundamentals, good dividends and its Saudi focused business,” commented Farouk Miah, head of equity research at NCB Capital.” He said: “We have raised our price target for Mobily by 8.2 percent due to the strong outlook of the broadband and corporate segment. On the other hand, our PT of STC is down by 1.9 percent due to weaker than expected Q3 2012 numbers and limited change in terms of outlook. STC has benefited from improved local operations; however, FX volatility remains a concern given around 31 percent of 2012 revenues are expected to be from abroad. The report notes that Zain KSA PT is down by 26 percent to S R8.4. This is primarily, due to the very weak Q3 2012 results (net losses increased YoY for the first time in two years), as well as ongoing concerns of how it will deal with its high interest costs and compete with STC and Mobily. NCB Capital continues to believe the sector has a strong growth potential. The outlook on broadband remains strong with lower cost handsets expected to increase penetration rates. The report considers that profit growth will be driven by growth in data, cost efficiencies, and international operations for STC, while Mobily’s recent MoU with Atheeb coupled with its joint venture with IBM positions it strongly to take market share in the corporate segment and drive its bottom-line. Miah added: “We believe the sector’s main concern remains price-led competition in the main growth segments i.e. data and corporate. Additionally, with increasing penetration rates across all segments, additional areas of growth may become difficult to source.” The Saudi telecom sector trades at a 2013e P/E of 8.6x, 10 percent below regional peers. A relatively stronger macro environment in the Kingdom is likely to support faster growth in the sector than in other regional countries. Summary of telecom-specific ratings: STC:NCB Capital retains its Overweight call on STC with the PT down 1.9 percent to SR 50.8. Growth will come from both its domestic and international operations with a focus on broadband. Margin pressures in key growth segments as well as the volatility of FX are the stock’s main concerns. Use of excess cash is a key catalyst; any increase in dividends will be seen as a positive, continued international expansion may be put pressure on the stock. Mobily:NCB Capital remains Overweight on Mobily, with the PT increasing by 8.2 percent to SR 88.6. The recent JV with IBM as well as the success of the MoU with Atheeb will strongly position Mobily for growth in the corporate segment. Mobily remains well positioned to benefit from increased broadband penetration. The bonus share should be a short-term catalyst with the strong dividend outlook also supporting the stock. Zain KSA:NCB Capital remains Neutral on Zain KSA, with its PT falling significantly to SR 8.4. Currently, the company’s main concern is refinancing its debt under improved terms; however the long-term concern remains its ability to effectively compete with STC and Mobily. Due to its weak balance sheet, capex investment remains behind what is required to compete effectively. A significant restructuring of its business model is needed to improve the outlook of Zain KSA.