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Are Indian telcos defensive?
Sep 20, 2010

Stocks can be divided into two broad categories on the basis of their performance vis--vis economic cycles. They can be cyclical stocks or defensive stocks (non-cyclical stocks).

Investopedia defines defensive stocks as 'stocks that provide constant dividends and stable returns regardless of the state of the overall stock markets. This means that defensive stocks tend to remain stable during the various phases of the economic cycles.

So which company would provide stable earnings in good as well as bad times?

The answer is simple. This would be a company that is providing non-discretionary or essential goods and services that are necessary for everyday life.

Using this definition, let us try to explore if the Indian telecom companies are defensive or not.

Business: Telecom companies provide wireless and fixed line telecommunication services. These are non-discretionary services as the need to communicate is not a function of our income. Mobile phones are now an essential part of our lives. Therefore, in terms of the line of business, it provides a service that is essential for our everyday life.

Stable returns and dividends: Let us look at the earnings quality of the Indian telecom companies on a historic basis.

Source: Company reports

As shown in the chart, ROE (Return on Equity) has remained stable for Bharti although it has come down in recent times due to excessive competition. However, for Reliance Communications (RCOM) and Idea Cellular, ROEs have been quite volatile.

In terms of dividends, only Bharti has declared a dividend and that too the maiden dividend was in FY09. However, it was quite miniscule.

Therefore, by this measure, only Bharti appears to be defensive.

Stock performance: By definition, the defensive stocks are expected to perform when markets are down and remain relatively stable when markets are going up. Let us see if the Indian telecom companies have performed in this manner or not. What we will do here is to compare the relative performance* of the stock with the performance of the index to see if the inverse relationship exists.

Source: Yahoo Finance

Since 2004, Bharti has outperformed the index during bad times but has lagged performance during good times.

Source: Yahoo Finance

RCOM has underperformed the index during good and bad times.

Source: Yahoo Finance

Idea has consistently underperformed the index except for a short period of time when the company announced their acquisition of Spice Telecom.

Verdict: Indian telecom companies have not been defensive as a group. However, Bharti seems to be fulfilling most conditions of defensive stocks. It offers an essential service which is non discretionary in nature. It has consistently delivered on performance through high returns on equity. The dividend payout has not been very attractive. However, we expect this to improve once its acquisitions start to play out for the company. The best part is that it has outperformed the broader markets during bad times. While it may not really race up during the good times, it has nevertheless, remained stable even during good times. Therefore, Bharti is definitely a good example of defensive stocks in India.

*Relative performance is the % increase/decrease in the stock price vis a vis % increase/decrease in index. Therefore if index went up 10%, stock went up by 7%, then it means that the stock underperformed the index by 3%, i.e., 10%-7%. Therefore, in the chart, when the line moves up, it indicates outperformance or that the stock has performed better than the index and vice versa.

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