Econet loses its stable model portfolio status

Econet Wireless has lost more than half of its capitalisation since the beginning of the year. This is a gut wrenching time for institutional funds and retail investors alike who have held Econet as a defensive investment.

We too, had to remove Econet Wireless from our Emergent Stable model portfolio – a portfolio that demonstrates a conservative investment strategy.

The precipitous drop in price has almost been uniform in the last six months. If you still hold Econet shares, is it too late to jump ship? Or should you perhaps hold on in anticipation of a correction?

For the first time in more than five years, annual revenue dropped. Not by much- just a mere 1 percent. But nonetheless the fall is momentous. In our opinion, this may be the beginning of a series of successive declines in revenue.

Salary cuts are a signal that revenue enhancement efforts will not be enough to retain profitability. Net profit shrank by almost 41 percent to $70 million for year ending 2014. Recently published HY2015 results confirm the trend. Net profit went down by 52 percent.

The abridged financial results published in June show Econet’s diversification helped to avert a drastic fall in revenue. Revenue for broadband services which are part of cellular network services went up by 42.3 percent.

Econet services group did the heavy lifting going up by 64.9 percent. As more services reach the market we expect the services group to reinforce this growth theme.HY2015 results show revenue for cellular network operations going down by 22 percent and other services rising by 21 percent.

Based on the FY2014 results, we estimate that voice revenue could have slid by as much as 11 percent in the last financial year. Our pessimistic view for the total revenue outlook is supported by two obvious headwinds. A weakening in spending power for households and a 35 percent cut in tariffs. But the tariff cut was only implemented January 2015 – it has affected approximately two months of the last twelve months’ financial results ending February 2015.

We expect a more pronounced cut in voice revenues as the tariff cuts start to reflect in an entire financial year. Potraz has also promised further voice tariff cuts for year 2016. For a business unit that has historically accounted for not less than 75 percent of total group revenue, the results of a sharp fall in voice revenue could be severe.

Quality companies are viewed as having a strong competitive advantage, strong cash positions, high returns on invested capital and strong management. Regulation has reduced the telecoms industry into a utility business. That said, we do not think Econet will slip into losses any time soon, but we think the days of spectacular performance are now behind us. We expect further tariffs to be premised on whether the industry is still making abnormal profits.

Based on 2014 results we estimated total remuneration to be close to $80 million – Net profit was $119 million. Earlier we estimated that a 20 percent cut in remuneration across board would add $30 million to the bottom-line – Econet recently reported that the wage rationalisation and other cost cutting initiatives are saving the company $70 million – a figure equivalent to 2015’s net profit.

Asset based valuation methodologies have always suggested that Econet is undervalued. But the same could have been said a year ago and perhaps two years ago as well. Current price to book value is 0.38 – an insignificant ratio compared to regional peers.

Is Econet Wireless a bargain now? It all depends on whether Potraz will live up to their promise to cut tariffs for the next two years.  Keeping this promise will suggest a deeper haircut in voice revenues, putting pressure on profits despite a $70 million savings.

By Martin Chinyuku- Research Analyst at Emergent Research.

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