S&P downgrades Telkom

Standard & Poor’s Ratings Services has lowered its long-term corporate credit rating on Telkom from BBB to BBB-, considered lowest investment grade by market participants.

The company’s outlook is stable.

“We think the continued decline in fixed line and losses in mobile will result in further profit erosion,” S&P said.

“The downgrade reflects our expectations of Telkom’s gradual and sustained weakening of operating performance. We believe that the likely steady revenue growth from its fixed-broadband and mobile services are unlikely to offset, over the next two years, the sharp downward trend in its core fixed-line voice revenues,” it said.

The ratings firm pointed to the ongoing fixed-to-mobile substitution trend and rising pricing pressures from mounting competition, as well as a likely reduction in leased line revenues resulting from mobile operators’ increasing self-provisioning.

The downward trend in highly profitable fixed-line voice traffic, its high fixed-cost base and operating losses for mobile operations will likely further affect Telkom’s profitability over the next two years, S&P warned.

This, combined with a projected surge in capital expenditures, could result in sustained very weak free cash flow generation, it argued.

Revenue decline

“Overall, we project a low-single-digit total group revenue decline for Telkom in the fiscal years ending March 31, 2013, and March 31, 2014, and a further deterioration of its EBITDA margin to the 21%-23% range over the same period – a relatively weak level compared with peers-from 25% in the fiscal year ended March 31, 2012, and 27% in fiscal year ended March 31, 2011,” S&P said.

The ratings agency said it continues to assess Telkom’s business risk profile and governance and management as “fair” under its criteria.

Its assessment of Telkom’s financial risk profile remains “modest”, however, reflecting its robust operating cash flow generation and solid capital structure.

Management woes

S&P called out Telkom on the numerous changes in the company’s top management and board in recent years, which it said may have delayed the implementation and execution of its strategic priorities – notably the buildout of its mobile operations and the material upgrade of fixed infrastructure.

“We anticipate, however, that there will be a surge in capital expenditures between 2013 and 2015 – potentially in excess of 20% of sales – as necessary to fund its network investment plans. Management indicated that capital expenditures could reach R18 billion – R21 billion over the period,” the group said.

The higher capital expenditures were also likely to depress Telkom’s generation of free operating cash flow (FOCF), which may turn slightly negative over that period, S&P cautioned.

On the positive side, S&P reflected on Telkom’s primarily strong leadership position in South Africa’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,” it 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.

Outlook

S&P’s “stable outlook” for Telkom reflects it’s expectations of a low-to mid-single-digit decline in sales from Telkom’s core fixed-line business, gradual reduction of mobile operating losses, and the maintenance of a solid capital structure and conservative financial policy over the next two years.

The ratings agency said Telkom’s planned surge in capital expenditures stands to depress its generation of free cash flow, which could be negative over 2013 – 2015.

“Although unlikely in the next two years, we could further lower the ratings on Telkom in the event of a more significant weakening in the company’s business risk profile than we currently anticipate, its inability to sustain positive FOCF over the medium term, or a durable decline in credit measures to levels not commensurate with the current rating.”

“We believe that ratings upside is unlikely in the next two years, given the continued strain on the fixed-line business, and uncertainties concerning Telkom’s future business performance in domestic mobile activities,” S&P said.

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S&P downgrades Telkom