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Rel. Comm.: Will aggression pay? - Views on News from Equitymaster

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Rel. Comm.: Will aggression pay?

Jan 23, 2009

Performance summary
  • Net sales grow by 32% YoY during 3QFY09, 25% YoY during 9mFY09. Performance of the mobile services segment not enthusing given that revenues have grown by just around 12% YoY during the quarter.
  • Growth impacted by a steep 26% YoY decline in average revenue per user and 9% YoY decline in minutes of usage.
  • Operating margins expand by 2.7% YoY during the quarter on the back of lower access charges and license fees.
  • Net profits grow by a mere 3% YoY during the quarter on the back of lower other and interest income and higher depreciation charges.

Consolidated financial performance snapshot
(Rs m) 3QFY08 3QFY09 Change 9mFY08 9mFY09 Change
Sales 41,319 54,415 31.7% 122,007 152,036 24.6%
Expenditure 27,678 34,977 26.4% 78,738 99,132 25.9%
Operating profit (EBDIT) 13,641 19,438 42.5% 43,269 52,904 22.3%
Operating profit margin (%) 33.0% 35.7%   35.5% 34.8%  
Other income 7,423 4,087 -44.9% 15,557 16,138 3.7%
Interest expense/(income) (1,518) (1,496) -1.4% (3,916) (6,189) 58.0%
Depreciation 7,252 10,070 38.9% 20,197 27,888 38.1%
Profit before tax 15,330 14,952 -2.5% 42,545 47,343 11.3%
Miscellaneous income/(expenditure) - (358)   12,217 (1,644)  
Tax 1,379 153 -88.9% 3,109 (608) -119.6%
Minority interest 220 338 53.8% 12,664 1,767 -86.1%
Share of associates (3) (0) -90.3% (11) (7) -35.1%
Profit after tax/(loss) 13,728 14,103 2.7% 38,979 44,532 14.2%
Net profit margin (%) 33.2% 25.9%   31.9% 29.3%  
No. of shares       2,062.8 2,063.8  
Diluted Earnings per share (Rs)*         28.9  
P/E ratio (x)*         5.5  
* On a trailing 12-months earnings

What has driven performance in 3QFY09?
  • Reliance Communications’ (RCL) grew its net sales by 32% YoY during 3QFY09. Mobile services revenues grew by a mere 12% YoY. This growth was largely a result of subscriber additions as ARPU and MoU both recorded declines. The company added 5.3 m wireless subscribers during the quarter, taking its total base to over 61 m. Around 16% of this base is made up by GSM customers.

  • RCL extended its presence into the GSM market by launching services in 14,000 towns. The company is working on an aggressive pricing mechanism which is likely to be an unprofitable venture given that subscribers are likely to reduce their usage one the free trial period is over. Bharti’s management, in its conference call yesterday, said that RCL is targeting a ‘deal seeker segment’ which is not loyal to any brand and moves towards any company that offers an attractive proposition. While Bharti has not made this segment its target, RCL has a history of doing the same. This is considering the fact that the company deployed similar under-pricing measures when it had launched its CDMA services a few years back. Ultimately, the company had to book heavy losses as the ‘deal seekers’ did not end up paying their bills and the company had to terminate their connections thereby booking heavy losses.

  • While RCL’s management has continued with its tom-toming of the company’s ‘superior’ position against competitors in terms of service quality and pricing, we believe the management needs to take some lessons in humility given that the market is highly competitive and RCL has not been able to bridge the gap with the market leader despite so many years of running its operations. Agreed that the company had a baggage in the form of CDMA services, which has a high entry cost for the subscriber, but the fact is that competitors have always scored higher on service quality and coverage. This is seen in the relatively lesser volatility in their performance as compared to RCL’s.

  • RCL’s second services line of national and international long distance telephony grew sales by 26% YoY during the quarter. As for the third business segment of ‘Broadband’, sales grew by 43% YoY.

  • RCL’s operating margins expanded by 2.7% YoY during 3QFY09. This was on account of lower access charges and license fees that the company paid to its peers and government respectively. While the former declined to 10.4% of sales in 3QFY09 (from 18.9% in 3QFY08), the latter declined to 5.6% (8.1%).

  • RCL’s net profits grew by a marginal 3% despite a 43% YoY growth in operating profits. Pressure on the bottomline was brought about lower interest income and other income and higher depreciation charges.

What to expect?
At the current price of Rs 160, the stock is trading at a multiple of 5.5 times its trailing 12 months earnings. RCL continues to see pressure on its wireless business growth. This has been brought about by a decline in both ARPU and MoU. While wireless net additions have remained robust, there are increased chances that the company’s profitability could be impacted due to a fall in these two variables. The management seems confident of raking in a strong growth and ARPU upside from its GSM foray. However, we believe that execution will be the key to growth, especially considering that the GSM market is already so competitive. Also the fact that the company is under-pricing services by offering free trials, the venture is not likely to be profitable, at least to start of with. Telecom RCOM, BTVL, IDEA

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