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Sterlite Technologies (SOTL IN) Summary

Core Content

Sterlite Technologies (SOTL IN) is a leading provider of transmission solutions for the telecom industry, offering end-to-end optical fibers for various applications. The company is currently rated as a High Conviction BUY, with an unchanged target price (TP) of INR470, valuing at 12.5x FY20E EV/EBITDA and a 40% premium to peers to reflect higher EPS growth and ROE.

Main Points

• 1Q19 Performance:

  • EPS was 7% ahead of forecast at 21% of FY19E.
  • EBITDA margin improved by 680bps YoY to 27.9%, driven by higher capacity utilization and pricing.
  • Order booking was +92% YoY, with a book-to-bill ratio of 1.9x, indicating a strong order book.
  • The company is expected to maintain a 32% CAGR in revenue over FY19-21E, driven by improved OF pricing, increased capacity utilization, and the Indian Navy contract.

• EPS Forecast Adjustment:

  • The company tweaked its EPS forecast, increasing FY19 by +2% and decreasing FY21 by -4%, due to the Metallurgica acquisition and delayed revenue from the Indian Navy contract.
  • The stock price has fallen 20% in six months, slightly ahead of the 17% decline in the NIFTY MidSmallCap 400 Index, making it a good entry point.

• Metallurgica Acquisition:

  • Acquired in August 2018 for EUR46.7m, adding 3m fkm of OF cable capacity immediately and 2m fkm in the next 6-9 months.
  • The acquisition is expected to add 4.7% to FY19E net profit.
  • It enhances the company's European presence and adds to the product portfolio with new cables for Railways and Metros.
  • The acquisition is funded by 80% local currency debt and 20% internal cash, with a payback period of five years.

• Market Position:

  • SOTL is one of only eight fully integrated optic fibre manufacturers globally, providing a 12-15% cost advantage over peers.
  • It holds a 40% share in India's optic fibre market and 6% in the global market.
  • The company is well-positioned to benefit from the growing demand for optical fibre cables, driven by data traffic growth of 365% in India over the next five years.

• Price Drivers:

  • The company announced a spin-off of the power business with a guaranteed buyback by promoters at a fair value.
  • The stock is re-rating due to strong quarterly performance.
  • A INR35b contract with the Indian Navy is expected to add INR4.5b in 2H19 and more over FY20-21E.

Key Metrics

Revenue Segments

Key Financial Highlights

• EBITDA Margins: Expected to decline in FY20E due to new OF capacity and increased contribution from lower-margin system integration, but likely to improve in FY21E with better capacity utilization.
• Capex and Funding: Capex of INR11-13b in FY18-20E will be funded from internal cash flows and debt.
• Debt Structure: Net gearing is expected to decline from 101% to 39.6% by FY21E.
• Dividend Policy: Net dividend yield is expected to increase from 1.3% to 2.0% by FY21E.
• Free Cash Flow: Expected to be positive in FY21E with INR7,709.9m.

Strategic and Market Outlook

• Domestic Business: Domestic revenue increased to 55% of total revenue in 1Q19, up from 39% QoQ and +57% YoY.
• Export Share: Exports' share of revenue declined to 45% due to short-term domestic orders.
• Market Expansion: The company is expanding its OF capacity to 50m fkm by the end of 2019, with 10m fkm added by end-Dec 2018 and another 10m fkm by end-Mar 2019.
• 5G and Data Growth: The management expects 5G commercialization at scale by 2020 and large-scale deployments by 2020-25.
• Peer Comparison: SOTL's EV/EBITDA is at 12.5x, which is a 40% premium to peers, and its core EPS CAGR is forecasted at 40% over FY19-21E.

Swing Factors

Upside

• New orders in the network design segment.
• Faster commissioning of new OF capacity.
• Demand pick-up in India for optic fibre cables.

Downside

• Postponement of government expenditure for the Bharat Net project and other broadband initiatives.
• Delays in commissioning OF capacity.
• FX sensitivity to earnings due to increasing exports.

Conclusion

SOTL is positioned to benefit from increased demand for optical fibre cables and strategic expansion through the Metallurgica acquisition. Despite the 20% drop in its stock price, it is viewed as a good entry point with strong revenue growth and EBITDA margin improvement expected. The company's strong market position, diversified revenue streams, and high ROE support its BUY rating.