Near-term growth challenges to weigh on Tata Communications stock

Higher investments may cap margins in the near term

The stock of Tata Communications was the biggest loser in trade among the BSE 200 stocks on Wednesday, shedding over 5 per cent. The pressure on the stock of the communication solutions provider came amid growth and margin challenges in the near term. The lack of growth guidance for FY23 and downgrades also hit investor sentiment.

The company has stuck to its double digit revenue growth guidance for the data segment in the medium to long term. It has also maintained its medium term return on capital employed (ROCE) target of 25-30 per cent and operating profit margin goal of 23-25 per cent at its analyst meet recently. The lack clear timelines, however, is expected to be an overhang.

Say Naval Seth and Pulkit Chawla of Emkay Global, “Management sounded positive about the improving funnel rate, potential deal conversions, new product launches and increased investments. However, it continued to be noncommittal regarding revenue growth guidance.”

The brokerage, which has cut its FY23-25 operating profit by 3-8 per cent (and target price to Rs 1,155) due to delay in revenue recovery and lower margins, believes that double-digit revenue growth is essential for sustaining a re-rating.

Further, the stock which saw a 30 per cent correction post muted March quarter results will continue to remain range bound until the company is able to achieve the targeted top line growth on a sustainable basis, believe the analysts.

IIFL Research too highlighted the growth challenges amid increased investments in the near term. “Though the growth in funnel and conversion rate has improved, Tata Communications continues to see some delay in the execution cycle, exacerbated by chip shortages. The company would continue to make investments (both operating and capital expenditures) across capabilities, even as some Covid-related cost tailwinds would normalise (reverse) in FY23.”

Given the investments in the business, expansion of operating profit margin and return on capital employed too might be challenging, they add.  The brokerage has cut its target price (to Rs 1,037) and is building in a net profit decline of 11 per cent in the current financial year.

While the two brokerages have cut their target prices, ICICI Securities has maintained its stance on the company with an unchanged target price of Rs 1,600. “Though data services revenue growth was disappointing in FY22, we continue to keep faith as management strategy is anchored at driving faster and durable growth. Our estimates remain unchanged with a target multiple of 20 times FY24 earnings estimates.”

At the current price, the stock which has corrected 35 per cent since its April highs is trading at 15 times its FY24 earnings estimates. Investors should await benefits from its growth strategy to reflect on the revenue and margin parametres before considering the stock.