Shares of telecom major Bharti Airtel and Idea Cellular rose nearly 2 percent on Friday after Bank of America Merrill Lynch (BoAML) upgraded both the stocks to "Buy" from its earlier "Neutral" rating.
According to BoAML, three factors should drive stock upside: 1) deep (20-40%) underperformance over last 12-months; 2) policy decisions in areas like spectrum pricing could be favorable hereon (unlikely to get worse at least) leading to potentially lower cash outflow from operators, and 3) strong FY14-15 earnings growth (+30-40%) should help to ease valuations. Current EV/EBITDA multiples (~6.5x) are not cheap at 15% premium to GEM wireless average but may revert to 25-30% premium as policy risks fade.
BoML sees room for upside in tariffs. "Our earnings outlook for the industry, including Bharti and Idea, is unchanged after the 2G auctions. We have not built any tariff hikes into our forecasts, but the auction reaffirmed our recent view that competitive pressures are moderating. Large tariff hikes may be deferred in anticipation of policy softening but floor for tariffs could rise given that players like Telenor have won relatively expensive circles and industry seems unanimous about the need for better price economics," it said in its report.
On the recently concluded 2G auction, the broking firm said it was "surprised" by the outcome. The 2G spectrum auctions ended flat on Wednesday with nearly half the spectrum seeing no bids and the government winning revenues of only Rs 9,407.64 crore, instead of the Rs. 40,000 crore revenue target.
"The 2G (1800MHz) auction outcome surprised us on three fronts: (1) neither Delhi nor Mumbai circles had any takers despite Telenor's interest in Mumbai among the metros, we expected only Delhi to fail; (2) of the 18 circles that saw bids, the winning price did not exceed the reserve price for 17 circles; and (3) fears of irrational behavior by new entrants (eg, Videocon) proved misplaced," BoML said in its report.
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