Stability in margins key catalyst for Saudi telecom sector, says NCB Capital report
Source: NCB Capital , Author: Posted by BI-ME staff
Posted: Thu March 22, 2012 11:42 am

SAUDI ARABIA. NCB Capital, Saudi Arabia’s leading wealth manager and the Kingdom’s largest asset manager, maintained its cautiously optimistic view on the Saudi telecom sector as margins remain under pressure due to price led competition.

 NCB Capital believes stability in margins is a key catalyst for the sector.

NCB Capital maintained its overweight rating on STC with a PT of SR50.2 (upside of 25%) and Mobily with a PT of SR75.5 (upside of 21%), and downgraded its rating on Zain KSA to underweight with a PT of SR7 (downside of 37%).

“Our price targets for STC and Mobily have increased by 12% and 13% respectively on the back of good 4Q11 results, as well as an expansion in multiples given the strong dividend outlook (Mobily) and strong continued domestic growth (STC),” said Farouk Miah, Head of Equity Research at NCB Capital.

“Our PT for Zain increases by 25% due to lower risk premium on the stock. However, given the recent strong performance in the stock, which we believe is unjustified, we have downgraded it to underweight. Our current PT does not factor in any potential balance sheet restructuring at the company which could lead the fair value to increase due to lower number of shares.”

According to the report, a key concern for the sector is continued price led competition, especially for the international calls segment. This led to margin pressure for the sector in 2011 and if continued could further pressure margins in 2012. NCB Capital believes the main telecom operators realize that this price led competition does more harm than good and thus NCB Capital expects some stability in margins in 2012.

Mr. Miah went on to say: “We continue to believe that the sector has good growth potential, particularly in the broadband segment, and we believe profit growth will be driven by a higher focus on value-added services (particularly broadband), costs efficiencies and benefits derived through international exposure (for STC).

“We believe the telecoms sector in Saudi continues to remain attractive, trading at an average 2012e P/E of 8.8x, 9% below regional peers. This is despite the relatively stronger macro environment in Saudi which should fuel faster growth in the telecom sector than in other regional countries.”

Outlook Summary:

NCB Capital expects total revenue for the three stocks under coverage to increase by 9.2% YoY to SR90bn in 2012 driven by an increased broadband subscriber base, growth in the Saudi corporate segment and higher equipment sales for Mobily.

“We believe STC will continue with good domestic growth as it leverages its wide array of products through bundled packages. As data and broadband continues to grow in Saudi, Mobily should continue to benefit from its scale of network,” Mr. Miah commented.

On data, the latest CITC information indicates that the broadband penetration rate reached 40.5% of the population by the end of 3Q11 (11.5mn users).  For Mobily, 22% of revenues came from Data in 2011, up from only 9% in 2008.

Mobily expects this to reach 24-25% in 2012.  STC claims it has 52% of all broadband subscribers in Saudi Arabia. “Given the introduction of mid and low end smart phones, improved technical capability enabling use of richer media content, coupled with the young population of Saudi Arabia, we believe this segment will continue to grow in the coming years,” explained Mr. Miah.

NCB Capital believes Zain continues to be aggressive on pricing which is leading to continued ARPU pressure for the whole sector in 2012. This is being partially offset by converting users to postpaid (where average ARPU is higher) and the growth of the data segment.

Mobily management claim 12% of subscribers are currently post-paid with growth expected in this in the coming years. For STC, around 25% of subscribers are post-paid.  NCB Capital believes ARPU pressures will remain in 2012 due to price based competition, although firms are using the data business and post-paid subscribers to reduce the impact of this pressure.

Margins will continue to remain under pressure due to price led competition, especially in the international voice segment, the report highlighted. NCB Capital believes the main cost line holding back margin gains is access/interconnection charges with other gross and operating costs relatively well managed.

“Although we believe margin pressure in 2012 YoY will be less than in previous years (14 bps decline vs. 21 bps in 2011) we believe as long as price led competition remains fierce and there are no changes to access/interconnection charges, then it will be difficult for margins to grow,” commented Mr. Miah.

YTD the Saudi telecom sector is up 29% against the TASI which is up 19%. NCB Capital believes the 18-19% gains in STC and Mobily are justified given the strong financial performance of STC in the domestic market, as well as the increase in dividend quantity and frequency for Mobily. Zain KSA is up 100% YTD; NCB Capital believes most of these gains are from speculative investors taking advantage of the low nominal price of the stock.

“However, despite the strong performance of STC and Mobily, we believe upside remains on both stocks given the attractive valuation (9.8x 2012e P/E for STC and 7.8x 2012e P/E for Mobily) as well as continued growth outlook.

"For Zain KSA, any investment case is largely based on the successful restructuring of its balance sheet which is far from certain of proceeding smoothly. For now, we believe the risks on Zain outweigh the upside potential,” Mr. Miah concluded.

Ratings Summary:

NCB Capital remains overweight on STC with PT increasing to SR50.2. Bottom-line progress in its international operations alongside continued growth in the Saudi market, are key drivers for the business. After six years of consecutive EBITDA margin declines, stability in margins is vital. Price-led domestic competition and FX exposure are key areas of concern.

NCB Capital remains overweight on Mobily with a PT of SR75.5. As expected, the increase in size and frequency of dividends has led the stock to gain 20% in the past 3 months. Although YoY profit growth is expected to slow in 2012, growth will continue to be supported by gains in data, stable ARPU and increased equipment sales.

Zain KSA
NCB Capital downgraded Zain KSA to underweight, despite PT increasing to SR7 off the back of a lower risk premium. With ongoing management change and high competition, financial progress in the short run will be difficult. The successful completion of its proposed balance sheet restructuring is vital in building an investment case for Zain.



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