Telkom retains negative outlook by S&P

Standard & Poor’s Ratings Services has retained its negative outlook for telecoms group, Telkom, and views the group’s business risk profile as “fair” and its financial risk profile as “modest.”

Its “BBB” long-term corporate credit rating was affirmed.

“The ratings on Telkom primarily reflect its strong leadership position in the country’s fixed-line telecoms market, good growth prospects in the broadband market, our opinion of the company’s robust operating cash flow generation, and its maintenance of a prudent financial policy,” S&P said.

The ratings are constrained, however, by the structural decline in Telkom’s fixed-line voice traffic, ongoing access line losses, its high fixed-cost base, material risks associated with the future performance of the company’s mobile telephony business, and increasing competition, the ratings group said.

Telkom reported gross consolidated financial debt of about South African rand (ZAR) 7.2 billion or roughly USD860 million on March 31, 2012.

S&P base-case operating scenario

S&P points to a “resilient performance” with Telkom’s revenue off by 1% year-on-year in the fiscal year ended March 31, 2012. “Nevertheless, we expect Telkom’s core fixed-line operations to suffer over the next two years from the sharp downward trend in voice traffic and steady access line losses,” said S&P.

“This trend will likely stem from ongoing fixed-to-mobile substitution, rising pricing pressures due to mounting competition, and reduced dependency of mobile operators on Telkom for transmission capacity,” it continued.

However, as in fiscal year 2012, S&P expects Telkom to continue to offset, in part only, the impact of these challenges on its revenues by growth in broadband, its move of traditional traffic revenues into annuity-type products, and the development of its mobile operations.

Standard & Poor’s projects a low-single-digit revenue decline for Telkom in the fiscal year ending March 31, 2013.

Profitability pressures

The rating agency believes that pressures on Telkom’s profitability are building and are likely to persist over the next two years, given the projected revenue erosion in the profitable voice fixed-line segment, the company’s high fixed-cost base, and projected sizable operating losses for its mobile operations.

“We anticipate a deterioration of EBITDA margin to potentially less than 25% over the next two years, after the contraction to 25.4% in fiscal year 2012 from 27.7% in fiscal year 2011. This factors in, however, our expectations of cost-cutting actions implemented by management, which could enable the company to preserve a solid EBITDA margin of close to 35% in the fixed-line segment,” S&P said.

It notes that Telkom’s first 18 months in the wireless market has been “tough”, due to lack of scale, stiff competition, and material distribution issues.

“Management’s focus on solving distribution issues, expanding data network coverage, and increasing the pipeline of products should now enable Telkom to compete more effectively, in our opinion. We believe that Telkom’s sizable transmission capacity, the opportunity to leverage its large corporate customer base through fixed-line and mobile bundle offerings, and the good long-term growth potential of mobile broadband, should enable Telkom to gradually gain market share. However, we think it will be difficult for Telkom to build a profitable mobile business in such a competitive market,” S&P said.

Despite an anticipated EBITDA decline, S&P believes Telkom should continue to generate robust operating cash flow in the fiscal year ending March 31, 2013.

“We anticipate, however, that there will be a surge in capital expenditures in the fiscal year ending March 31, 2013, at least-potentially in excess of 20% of sales-to fund a mobile network rollout and material upgrade of the fixed infrastructure.”

S&P says Telkom’s decision not to pay dividends for fiscal 2012 was the right move.

Liquidity

The rating agency puts Telkom’s liquidity as “adequate”. On March 31, 2012, Telkom’s liquidity position was supported by ZAR1.168 billion of cash on hand, about ZAR2 billion of liquid short-term investments, and roughly ZAR4 billion of undrawn committed credit facilities.

This excludes the new ZAR10 billion domestic medium-term note programme registered on the Johannesburg Stock Exchange in December 2011, which altogether should provide Telkom with some financial flexibility to fund the development of its mobile business, S&P says.

“We understand Telkom plans to invest a maximum of ZAR6 billion over five years in a selective rollout of dual second- and third-generation sites.”

“We consider these liquidity sources as adequate to cover Telkom’s short-term debt of ZAR1.292 million, mostly consisting of its ZAR1.060 million bond that matured in April 2012. The latter was repaid at maturity through the issuance of commercial paper of ZAR900 million and ZAR200 million maturing on December 31, 2013.”

“Importantly, we expect the company to proactively work on lengthening its debt maturity profile in the coming months. We also expect the company to continue to limit its overall exposure to foreign currency debt,” S&P said.

Outlook

S&P says its negative outlook reflects the risk of a one-notch downgrade over the next 12 months if continued strong pressure on Telkom’s traditional fixed-line voice revenues, operating losses for mobile operations, and heightened competition were to result in a prolonged erosion of revenues and profitability.

“The surge in capex stands to depress Telkom’s generation of free cash flow, which could be negative over the next two years. Combined with shareholder distributions, this may lead in turn to an increase in the company’s leverage,” the group said.

S&P says it could lower the rating on Telkom in the event of a further marked weakening in the company’s business risk profile, its inability to sustain positive Free Operating Cash Flow (FOCF), or a durable decline in credit metrics to levels not commensurate with the current ‘BBB’ rating, notably adjusted ratios of gross debt to EBITDA in excess of 1.5x or funds from operations to debt at or below 50%.

“We could revise the outlook to stable if we anticipate stabilisation of the core fixed-line operations, maintenance of the EBITDA margin of at least 25%, pronounced progress in building a sizable and profitable mobile business, and if the company demonstrates its capacity to protect credit metrics in line with our rating expectations.”

“An outlook revision to stable would also hinge on Telkom’s maintenance of adequate liquidity, in particular through a lengthening of the debt maturity profile,” S&P said.

By close of trade on Tuesday (19 June 2012) Telkom was trading up on the JSE, having moved up 63 cents – or 3,10% – to R20.98.

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Telkom retains negative outlook by S&P