FOCUS: Pummeled by data law, telecom index still has chances to recover in H2

By Yekaterina Yezhova

MOSCOW, Jul 2 (PRIME) -- The telecommunications index advanced in January–June by a third of the rise of the broader MOEX Russia index, because the industry indicator was undermined by a small growth of its bellwether, MTS’ common shares, but supported by performance of Rostelecom’s common stock. Investors say prospects for the rest of the year are brighter, but the costly data retention law stays the main derailer for the companies’ dividend potential.

“Investors are wary about the Russian telecom market after several controversial initiatives have been adopted and because of general stagnation in the industry as the market is getting saturated and competition is becoming fiercer,” investment company Veles Capital analyst Artyom Mikhailin told PRIME.

“If the competition environment stays stable, digitization and rising demand for data traffic can become new growth drivers and bring investor appetite for the sector back, which will push quotes up.”

The telecommunications index grew 3.3% in the first half of the year, while the MOEX Russia added 8.8%.

Below is a breakdown of the telecom index’s weight as of June 28, meaning common shares if not indicated otherwise:

The core risk impacting all the operators is the data retention law, an expensive state initiative obliging operators to store content of subscribers’ voice calls and messages for six months from July 1. “Huge investment in complying with the law is among the key factors dwarfing growth of investment prospects of the industry,” said Dmitry Bedenkov, head of the research department at investment company IC RUSS-INVEST.

“Rising capital expenditures could restrict the companies’ ability to pay dividends that makes them less appealing from the point of view of dividend yield compared to foreign peers.”

In July–December, telecom stocks will trade along with the broader market. “We expect the Russian market, including the telecom quotes, to rebound in the second half of the year thanks to a rising gross domestic product,” said Zerich Capital Management senior analyst Viktor Markov.

MTS

The country’s major mobile operator MTS assessed its expenses to respect the data retention law at up to 60 billion rubles over five years, the highest sum among its local counterparts. The operator’s common shares, the backbone of the industry’s index, went up 0.8% since the beginning of the year in Moscow to 278.10 rubles at the June 29 closure, and its American depositary receipts (ADRs) lost 13.7% to U.S. $8.76 in New York as of the end of June 28.

“Earlier, MTS’ shares were depressed by court proceedings of its parent company, Sistema, with state oil giant Rosneft, which kept investors at bay. Now the situation is explained by possible sanctions against Sistema’s major holder Vladimir Yevtushenkov and his businesses: Sistema and MTS,” KIT Finance Broker analyst Dmitry Bazhenov said, adding that the scenario looks unlikely. “If no sanctions are imposed, the current prices of MTS are attractive.”

The sanctions threat is a new reason for worry among the U.S. investors, but “we think MTS has a good chance as the industry leader, and the operator could secure a good return on investment for shareholders thanks to a further rise in quotes and high dividends,” Mikhailin at Veles said.

Markov at Zerich said, “MTS has a high dividend yield of some 9%, this is why we could expect the company’s shares to recover in the second half of the year.”

Besides, MTS hugely supported the telecom index on June 29, the last trading day of the first half of the year, after statements about its shareholders’ approval of dividends for 2017 and an option of paying out over 5 billion rubles in dividends for January–June along with the board of director’s endorsement of another buyback for up to 30 billion rubles. On June 29 alone, MTS’ common shares rose 4% and the telecom index gained 2.9%.

MegaFon

General trends influence MegaFon, which is improving financial results and monetizing its infrastructure, the largest in the country, slower than the others, Mikhailin at Veles said, adding that the operator has a heavy debt and hugely inflated capital expenses.

MegaFon’s common shares lost 1.7% since the beginning of the year to 504 rubles in Moscow on June 29 and its global depositary receipts (GDRs) plunged 6.8% to $8.62 in London on June 28. The operator said it will spend 35–40 billion rubles on the data retention law over five years.

“Investors wait for the debt to shrink and the operator to have a steady cash flow growth to resume paying dividends, but it is still unclear how much time the operator’s investment cycle will take and what prospects these contributions will have. If MegaFon cuts debt and shows a good return on investment, its shares will be in demand,” Mikhailin said.

Markov at Zerich explained MegaFon’s woes by weak financial results and abstention from dividends. “At that, the company is considering returning dividend payouts in 2019, and its quotes could stabilize in the second half of the year, but if there is a problem with dividends, MegaFon’s stock will again be under pressure,” the analyst told PRIME.

Rostelecom

State-controlled Rostelecom performed strongly with common shares rising 14.6% since the beginning of the year to 73.22 rubles in Moscow on June 29. The company’s President Mikhail Oseyevsky said in mid-May the operator may need no additional investment in 2018 to fulfil the data retention law as it has a lot of own data storage facilities.

“The main driver in the growth of Rostelecom’s shares is the dividend yield, which is currently at 6.8% for common shares and 7.8% for preferred shares. The company could also start paying dividends twice a year,” Bazhenov at KIT Finance Broker said.

Markov at Zerich said Rostelecom has stabilized its financial results and holds a good dividend policy. “We can expect higher interest to Rostelecom’s shares until the end of 2018,” he said.

VEON

Local mobile operator VimpelCom said it would have to spend some 45 billion rubles on the data retention law over five years. The operator is not listed, but its sole owner, VEON, is and its ADRs tumbled 38.7% since the beginning of the year to $2.38 in New York on June 28.

“Despite quite strong results in Russia, VEON’s receipts plunged because of stronger competition in Italy, Bangladesh and Algeria. The future is worrying because it’s unclear how long competition and price wars will last. Additional pressure on the Russian OIBDA is exerted by refurbishing of Euroset’s stores received under a deal with MegaFon with return on investment, which is questionable, to appear only next year,” Mikhailin at Veles said.

(62.7565 rubles – U.S. $1)

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