MTS (MBT) is the best Russian telecom company in terms of its operational performance and dividend payment consistency. I view the company as a top pick in the Russian telecom sector in the medium term. The long-term outlook for the company doesn’t seem to be attractive, though.
MTS is a telecommunications company, offering mobile and fixed voice, broadband and pay TV services. MTS Russian mobile service revenues grew 3.1% in 2017 and 3.7% in 1Q18. The company’s Net Debt/EBITDA stays at 0.9x vs 1.9x for Rostelecom and 2.0x for MegaFon post share buyout. This gives MTS greater sustainability in the case of higher-than-expected capex related to data storage or any other potentially negative events.
MTS has the most generous dividend policy among Russian telcos with 10-11% expected dividend yield in 2018-2019. For the calendar years 2016–2018, MTS management set a target payout of Rub 25.0–26.0 per ordinary share (Rub 50.0-52.0 per ADR) for investors, while committing to a minimum cumulative payout of Rub 20.0 per share through two semi-annual payments. In the spring of 2019, the company will update its dividend policy. It’s highly likely that the new dividend policy will imply higher dividends, as MTS’ main shareholder AFK Sistema is under pressure after the lawsuit from Rosneft, which is demanding 171bn roubles ($2.8bn) in damages.
This summer has brought some interesting company-related events. Firstly, the company recently announced a share buyback (Rub 30bn over 2 years) which means additional yield to shareholders. Secondly, MTS has increased its stake in MTS Bank. As a result of the deal, MTS’s share in MTS Bank increased from 26.61% to 55.24%. AFK Sistema’s direct ownership in MTS Bank decreased from 71.87% to 43.24%. The operational results of MTS Bank will be consolidated in MTS’s financials so we can expect some increase in revenues and EBITDA. Finally, MTS has filed a case with a World Bank arbitration center for at least $750 million in compensation from Turkmenistan for the forced closure of its daughter company. Although, I doubt that MTS would be able to get a single dime from this case. The prospect of having to pay out legal damages comes at a time when the country can afford such expenses. The $750 mln fine equals to 17% of Turkmenistan’s nominal GDP ($42B), so it is obvious that this is an unbearable sum for payment and bores absolutely no relation to Turkmenistan’s ability to pay.
It’s also important to mention the possible sanctions against AFK Sistema key beneficiary Vladimir Evtushenkov because of claims that Evtushenkov’s company invested funds in construction in Crimea. At the same time, the official representative of AFK Sistema Sergey Kopytov stated that the company does not conduct any investment activity in the territory of the Crimea. In addition, there were no requests from the US on this issue, despite the fact that US congressmen in June were trying to check Evtushenkov's business for possible violations of the US ban. So basically there’s still no any strong evidence of Sistema’s activity in Crimea. By and large, any possible sanctions against Evtushenkov won’t directly affect operational performance of Sistema’s main assets including MTS. MTS’s business isn't exposed to American sanctions because the company has limited operations outside Russia. I also think that it’s not a big deal for Evtushenkov to get rid of assets in Crimea (if there’re any) if it will be required for avoiding sanctions.
Analysts’ estimates for MTS’ EV/EBITDA vary around 4.0x-5.0x but I picked the most conservative figure of 5.28x. Combined with the lowest P/E compared to peers, we can conclude that MTS is hugely undervalued considering its operational performance. I think it’s barely possible to find a telecom stock with >10% dividend yield with such cheap valuation as MTS has.
I see the following challenges/risks for Mobile TeleSystems in the mid-term:
- Capex associated with the Data Storage Law creates additional pressure for the company's FCF. The Data Storage Law came into effect on July 1, 2018. Telecom operators are required to keep information about mobile voice and SMS for six months from July 1, 2018, while internet traffic will need to be kept for one month from October 1, 2018. It will cost at least Rub 55-60bn (~$950 mln) of capex relating to associated costs for MTS over the next five years.
- The upcoming 5G technology adds further uncertainty toward the scale of operators’ spend on capex. 5G roll-out will cost up to Rub 300bn ($4.8B) for the key four operators over the next five years according to Megafon’s estimates.
- MTS can be substantially fined for the still ongoing Uzbekistan corruption case. In 2012, Ministry of Justice and securities regulator SEC began an investigation of three mobile operators - MTS, VEON, and Telia – for possible corruption in obtaining licenses through connections with Gulnara Karimova, the daughter of Islam Karimov, the former President of Uzbekistan. Telia and VEON have already paid its fines, so there's a chance that MTS will pay the fine too. Morgan Stanley estimates the potential fine at $400m (equal to the US part of the fine paid by Veon in a similar investigation in Uzbekistan), which would be equal to <5% of MTS's market cap.
- The mid-term macroeconomic outlook in Russia is negative. Less attractive USD/RUB exchange rates (Rub 56-58 in 2017, 62-65 in 2018) and scheduled VAT increase will negatively affect purchasing power in Russia. At the same time, Central Bank of Russia keeps the interest rate on hold because of possible inflation risks. The new US sanctions against Russia will also add some uncertainty to the Russian stock market and bring short-term volatility of ruble.
MTS definitely deserves your attention if you’re comfortable with company-related risks. However, MTS is exposed to the same industry trends as other Russian mobile telecoms with low-single digit-revenue growth and increasing capex in the long run.
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