Vimpelcom Ltd (NASDAQ ADR:VIP) is an integrated telecom service provider operating predominantly in Russia (41% of revenues) and is the third largest mobile operator in the country. It also provides telecom services in the CIS countries like Ukraine, Uzbekistan, Kazakhstan, Tajikistan, Armenia and Georgia. It also operates in Italy and African countries like Zimbabwe, Central African Republic, Burundi, Algeria and Laos.
Italy is also a major market as it contributes 30% of revenues to the company.
VimpelCom valued at $10 billion is famous for its high dividend payouts. In FY13 the total dividend per share was $1.24 even though the EPS was negative at ($0.83). The dividend payout increased more than 50% year-on-year in FY13 to result in a dividend yield of 15%.
The recent performance of the company in H1FY14 has been rocky and it has been reflected in the stock price as well, which has almost halved from its early 2014 high of $13 to the current $6 per share. The operating revenue and operating profit have declined organically by 6% and 7% respectively in H1FY14 over H1FY13 due to macroeconomic conditions- especially the ongoing Ukraine crisis, which has affected Russia, the company's largest market.
Stock price under pressure from below par performance
In the Q2FY14 results released in August 2014, the reported operating revenue declined by 11% to $5.1 billion from $5.8 billion last year. The EBITDA margin declined by 140 basis points to 41% in the second quarter of 2014 due to the effect of incremental costs from earlier investments in 3G, 4G/LTE and mono-brand stores. The customer base increased 2% year-on-year to 220 million supported mainly by expansion in Africa and Asia.
The net income declined to $131 million in H1FY14 from $888 million in H1FY13 due to higher depreciation from capital expenditure and foreign currency translation losses.
The capital expenditure as a percentage of revenue increased year-on-year to 17% from 12% leading to higher depreciation in the current year. The EPS was only $0.08 for H1FY14 compared to $0.59 in H1FY13. The full year EPS expected by analysts for 2014 is $0.56, which looks difficult to achieve given the low EPS generated in the first half of 2014.
Why VimpelCom could be a huge value play
One of the positive factors that give comfort to investors is the double-digit growth record of mobile data revenue stream in the last four quarters, which comes despite an overall decline in organic revenues.
The mobile data revenue has been the highest growth contributor to the company among other segments like fixed line and broadband services. Russia and Italy have been the frontrunners in growing usage of mobile internet.
With introduction of 3G services in Pakistan, Algeria and other CIS countries, the data revenue stream is expected to lead overall revenue growth in the near future. The net debt to EBITDA ratio is expected to remain close to 2.5x levels.
Interest savings are expected due to refinancing of WIND assets in the current year. The cash position is comfortable at $5.5 billion and the capex for FY14 is expected to be at 21% of revenue and can be covered using existing cash balance.
The stock was trading at a trailing P/E of 20x its FY13 earnings when it was at its peak of $12 in late 2013. Based on the expected earnings for FY14 of $0.56, the stock is trading at a forward P/E of 10x at current price of $6.
Though a decline in EPS is inevitable in FY14 given the decline in organic revenue in last 4 quarters, it has to be viewed in perspective with other similar Russian telecom service providers like Mobile Telesystems OAO (NYSE: MBT) and Megafon OJSC (OTC: MFOYY). The entire market is facing serious macro-economic factors that could turn out to be a blessing in disguise for investors.
For instance, Megafon OJSC another leading Russian telecommunication services provider reported 16.5% decline in net profit while capex was up 31.4%, which again indicates how the companies are focused on expanding operations in the next few years. This indicates that the overall outlook might be brighter than the current picture suggests.
MBT is yet another player in the Russian telecom market that faces the same macroeconomic challenge experienced by VIP and MFOYY. The company has 105 million subscribers in Russia and CIS regions and boasts a market capitalization of $11.5 billion. It posted total revenue of $2 billion in Q2FY14, which implies a growth of 1.6%. On the other hand, mobile data revenue grew by 39% in the second quarter results. However, in a similar fashion to its rivals, net income declined by 27% year-on-year.
MBT has registered better growth numbers than VIP and hence an incremental valuation of 5x over VIP would be justified. Therefore, VIP, which is similar to MBT in all respects except for lower growth rates has the potential to trade at around 13-15x its FY14 EPS. In general, at current price and trading at a forward P/E of 10x, VimpelCom is significantly undervalued.
How the macro effect is affecting the Russian market
From the point of view of the macroeconomic angle, there is a clear explanation as to why VIP and MBT are trading at lower valuations despite only a small decline in growth rates in the current year. The ongoing Ukraine crisis and the resulting sanctions and export bans by U.S. and western European countries on Russia has generated a negative outlook on the Russian economy.
This has resulted in the currency depreciating by 7.7%. The inflation has increased to 8% and the Russian central bank increased interest rates up to 9.5% in the last month. The Bloomberg Russia equity index fell by 4.4% in October. Therefore, the Russian index in general has been downgraded and trading at lower valuations than its long-term average.
The CAPE (cyclical adjusted price earnings) ratio, which is generally used to identify whether an index in undervalued or overvalued in comparison to its long term mean can be used to analyze the present case. The CAPE ratio for the Russian index in YTD 2014 is 6.42, which is very low in comparison with the average range of 15-20x. As a contrarian indicator, this ratio signals a buy call into the Russian index for the long term when the P/E will rise once the political situation becomes stable.
VimpelCom, being among the top three telecom companies in Russia, has also been affected by the overall negative sentiment surrounding Russia and has been downgraded to lower valuations.
However, considering the Russian economy (one among the emerging BRIC nations) to have long term growth prospects, the EPS growth rates of VimpelCom is bound to increase after shaking off the ongoing slowdown.
Therefore, the stock is currently available at cheap valuations for long-term investors, and now could be the best time to take a keen interest on it before it is too late.
Disclosure: No positions