KESTREL CAPITAL Member of the Nairobi Securities Exchange March 2014 SAFARICOM LTD Recommendation: ACCUMULATE We maintain our ACCUMULATE recommendaon on Safaricom with a 1 year target price of KES 12.56 repre- senng upside of 6.9% which is primarily limited by its current market valuaon. The potenal upside along with the dividend yield of 3.9% should provide total return of 10.8%. We forecast that EPS will grow 43.1% y/y to KES 0.63 in FY14 driven by faster growth in non-voice revenues (+31.2% y/y), relave to voice revenue (+12.2% y/y) and improvements in margins (contribuon margin: +157bps y/y to 64.4%, EBITDA margins: +241bps y/y to 42.0%). Beyond FY14, we expect data and M-PESA to be the drivers of revenue growth as costs decelerate as a result of improving cost efficiency. Stable capital expenditure and negave net debt will mean that the addional cash generated from the improving performance will result in higher dividends (3-year forward CAGR of 47.8%) only limited by potenal acquisions of more fibre capacity or ancillary businesses (Safariom and Airtel have bid for Essar Yu). At current prices, the company has a trailing P/E of 26.7x and EV/EBITDA of 9.6x compared to the regional comparables average P/E of 12.2x and average EV/EBITDA of 6.9x. The company’s growth prospects (+44.9% y/y growth in EPS in 1H14), however, jusfy the premium. Posives Voice revenue growth will be driven by increased subscribers (+8.3% y/y in 1H14), lower churn (18.4% in 1H14 from 28.5% in 1H13), improvement in call quality and the organic growth of minutes of use Non-voice revenue will account for a larger poron of revenue (from 36.7% of total revenue in 1H13 to 39.4% in 1H14) on account of higher growth rates (non-voice revenue grew 30.2% y/y compared to voice revenues that grew 12.0% y/y in 1H14) The rise in M-PESA revenues (+19.8% y/y in 1H14) will be driven by increased acve subscribers (+19.2% y/y in 1H14) in the short term and increased M-PESA usage in the longer term Promoons, bundles and growing subscribers will drive growth in SMS revenues (+48.7% y/y in 1H14) Increases in acve mobile data customers (+51.7% y/y in 1H14) and usage will drive the growth in mobile data revenues (3 year forward CAGR of 23.1%) The new fibre opc network will support the growth in fixed data subscribers EBITDA margin expansion (EBITDA margin is 41.7%) will be driven by growth data revenues (mobile data and fixed data EBITDA margins are 55.0% and 43.0% respecvely) The company will earn net finance income due to more cash than borrowings Free cash flows to rise (3 year forward CAGR of 49.5%) on growing EBITDA and stable capital expenditure( at approximately KES 27.0bn per annum) We expect higher dividends (3 year forward CAGR of 47.8%) as free cash flows connue to grow Negaves Handsets sales decline ahead of the introducon of 16.0% VAT Accelerated depreciaon will drag down earnings growth We expect increased compeon on M-PESA and fixed data from new players Safaricom might be a target for increased regulaon due to its dominant market posion FY10 FY11 FY12 FY13 FY14F FY15F FY16F Revenue 83.96 94.84 107.00 124.29 146.12 166.45 189.48 y/y % ch 13.0 12.8 16.2 17.6 13.9 13.8 EBITDA 36.61 35.73 37.50 49.18 61.00 69.99 81.04 y/y % ch (2.4) 5.0 31.1 24.0 14.7 15.8 EPS 0.38 0.33 0.32 0.44 0.63 0.77 1.03 y/y % ch (13.2) (4.0) 38.9 43.1 22.4 34.3 DPS 0.20 0.20 0.22 0.31 0.38 0.58 0.76 y/y % ch - 10.0 40.9 22.7 52.6 31.0 EV/EBITDA 12.9 13.4 12.8 9.6 7.6 6.4 5.3 P/E 30.9 35.6 37.1 26.7 18.7 15.2 11.4 Div yield 1.7 1.7 1.9 2.6 3.2 5.0 6.5 (Source: Company, Kestrel Capital Research) Bloomberg Ticker : SAFCOM KN Reuters Ticker: SCOM NR Share Statistics Price (KES) 11.70 Issued shares (m) 40,044.6 Market cap (USD m) 5,422.7 Year end March Free Float % 24.9 Foreign ownership (%) 13.1 Av daily trading vol (USD) 1,573,937 Price Return Absolute Excess 3m 13.0% 11.2% 6m 49.0% 33.8% 12m 96.6% 66.7% Price Trend Source: NSE Analyst Kuria Kamau [email protected]+254 20 2251 758 +254 20 2217 049 www.kestrelcapital.com 4.00 5.00 6.00 7.00 8.00 9.00 10.00 11.00 12.00 13.00 95.00 105.00 115.00 125.00 135.00 145.00 155.00 NSE All Share Safaricom
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KESTREL CAPITAL Member of the Nairobi Securities Exchange
March 2014
SAFARICOM LTD
Recommendation: ACCUMULATE We maintain our ACCUMULATE recommendation on Safaricom with a 1 year target price of KES 12.56 repre-
senting upside of 6.9% which is primarily limited by its current market valuation. The potential upside along with
the dividend yield of 3.9% should provide total return of 10.8%. We forecast that EPS will grow 43.1% y/y to KES
0.63 in FY14 driven by faster growth in non-voice revenues (+31.2% y/y), relative to voice revenue (+12.2% y/y)
and improvements in margins (contribution margin: +157bps y/y to 64.4%, EBITDA margins: +241bps y/y to
42.0%). Beyond FY14, we expect data and M-PESA to be the drivers of revenue growth as costs decelerate as a
result of improving cost efficiency. Stable capital expenditure and negative net debt will mean that the additional
cash generated from the improving performance will result in higher dividends (3-year forward CAGR of 47.8%)
only limited by potential acquisitions of more fibre capacity or ancillary businesses (Safariom and Airtel have bid
for Essar Yu). At current prices, the company has a trailing P/E of 26.7x and EV/EBITDA of 9.6x compared to the
regional comparables average P/E of 12.2x and average EV/EBITDA of 6.9x. The company’s growth prospects
(+44.9% y/y growth in EPS in 1H14), however, justify the premium.
Positives
Voice revenue growth will be driven by increased subscribers (+8.3% y/y in 1H14), lower churn (18.4% in
1H14 from 28.5% in 1H13), improvement in call quality and the organic growth of minutes of use
Non-voice revenue will account for a larger portion of revenue (from 36.7% of total revenue in 1H13 to
39.4% in 1H14) on account of higher growth rates (non-voice revenue grew 30.2% y/y compared to voice
revenues that grew 12.0% y/y in 1H14)
The rise in M-PESA revenues (+19.8% y/y in 1H14) will be driven by increased active subscribers (+19.2% y/y
in 1H14) in the short term and increased M-PESA usage in the longer term
Promotions, bundles and growing subscribers will drive growth in SMS revenues (+48.7% y/y in 1H14)
Increases in active mobile data customers (+51.7% y/y in 1H14) and usage will drive the growth in mobile
data revenues (3 year forward CAGR of 23.1%)
The new fibre optic network will support the growth in fixed data subscribers
EBITDA margin expansion (EBITDA margin is 41.7%) will be driven by growth data revenues (mobile data and
fixed data EBITDA margins are 55.0% and 43.0% respectively)
The company will earn net finance income due to more cash than borrowings
Free cash flows to rise (3 year forward CAGR of 49.5%) on growing EBITDA and stable capital expenditure( at
approximately KES 27.0bn per annum)
We expect higher dividends (3 year forward CAGR of 47.8%) as free cash flows continue to grow
Negatives
Handsets sales decline ahead of the introduction of 16.0% VAT
Accelerated depreciation will drag down earnings growth
We expect increased competition on M-PESA and fixed data from new players
Safaricom might be a target for increased regulation due to its dominant market position
and higher voice ARPUs (+9.6% y/y, +2.9% h/h): Safaricom managed grow its total sub-scribers by 8.3% y/y (+7.2% h/h) despite already having a significant share of the industry subscribers (65.1% as at 31 March 2013). During the period, Airtel Kenya (Safaricom’s clos-est competitor by subscriber numbers) raised its call rates to match Safaricom’s. The attrac-tiveness of Safaricom’s products, in particluar M-PESA, attracted more subscribers on to the network as indicated by the decline in churn from 28.5% in 1H13 to 18.4% in 1H14. The rise in voice ARPUs (+9.6% y/y, +2.9% h/h) was a factor of higher minutes of use even as the effective yield per minute declined following the 20.1% y/y cut in Mobile Termination Rates. Going forward, we expect voice ARPUs to keep growing due to higher minutes of use as call quality improves. Also, last year’s subscriber numbers in 2H13 were affected by the switching off of counterfeit phones and unregistered lines. We don’t expect the same to reoccur in 2H14.
SMS revenues increased 48.7% y/y (+8.4% y/y) driven by the Bonyeza Ushinde promo-tion: Last year, Safaricom ran the Bonyeza Ushinde promotion which contributed signifi-cantly to the 30.0% y/y growth recorded in FY13. The effects of the promotion were sticky as the higher volumes recorded during the promotion continued into the second half of 2013. In 1H14, Safaricom ran the second round of the promotion but with a higher price
Safaricom Update March 2014 KESTREL CAPITAL
per SMS. SMS ARPU rose 45.9% y/y (8.0% h/h) in 1H14. The additional effect of growing subscribers numbers as well as the popularity of the promotion amongst existing subscrib-ers resulted in much higher SMS volumes. Also, the new SMS bundle products, following the removal of the unlimited SMS bundle, continues to generate higher SMS volumes at a slightly higher average price per SMS than the unlimited SMS bundle did.
Fast growth in active mobile data customers (+51.7% y/y) drove the 43.1% y/y growth in mobile data revenues: As at end of March 2013, Safaricom was the largest mobile data provider with 74.4% of all mobile data subscriptions. Despite this, it was able to grow its active mobile data subscriptions by 51.7% y/y. A 21.0% cut in the average price per MB drove up mobile data usage by 18.0%. While there was some dilutive impact from the low-er prices, we expect usage to continue growing going forward. The company announced that it would build the largest 4G network in the region over the next 24 months which will continue to drive the growth of mobile data.
M-PESA revenues rose 19.8% y/y (9.6% h/h) on increased subscribers (19.2% y/y): The rise in M-PESA revenues (+19.6% y/y, +9.6% h/h) was largely due to increased subscribers. M-PESA subscribers grew 19.2% y/y (+6.1% y/y). The benefits the newly launched products (e.g. LIPA NA M-PESA) were yet to be felt as average usage per customer only grew 2.0% y/y. M-PESA continues to have a lot of growth potential should the benefits of the new prod-ucts begin to accrue.
EBITDA margin rises 399bps to 41.7%: Direct costs increased 8.2% y/y (+6.7% h/h ) while operating costs were up 11.8% y/y (3.5% h/h). This was much slower than the 17.1% y/y growth in total revenue. The result was an improvement in EBITDA margin to 41.7% in 1H14 from 37.7% reported in 1H13. Some of the cost improvement initiatives include in-creasing the number of airtime top-ups that are being carried out on M-PESA (34.0% of total top-ups) which lowers the amount paid to airtime dealers.
Free cash flows rose 149.9% y/y: Following the 29.4% y/y (+7.3% y/y) increase in EBITDA,
improvement in working capital management (KES 2.06bn) and subdued capital expendi-
ture (-31.9% h/h, +34.8% y/y), free cash flow rose 149.9% y/y to KES 12.9bn. The company,
however, expects capital expenditure to rise in 2H14 to KES 26.0bn to KES 27.0bn for FY14.
The company also raised its guidance for FY14F free cash flow from a range of KES 15.5bn -
KES 17.5bn announced at the start of the year to a range of KES 20.0bn – KES 21bn.