Kcell Joint Stock Company — Handsets and low churn drive forecast increase

Kcell Joint Stock Company (Kazakhstan Stock Exchange: KCEL)

Last close As at 19/04/2024

5.25

0.00 (0.00%)

Market capitalisation

1,050m

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Research: TMT

Kcell Joint Stock Company — Handsets and low churn drive forecast increase

After a Q2 affected by COVID-19, Kcell’s revenue and profit growth accelerated sharply in Q3. Handset sales (+124% y-o-y to KZT11bn) were the main surprise (again), but there were encouraging trends in the services business also. Kcell posted its highest net additions in six years with churn remaining close to record lows. These trends are further evidence of an improving market and the success of Kcell’s new strategy in our view. We raise our FY20 EPS forecasts by 23% to KZT120.

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Written by

TMT

Kcell Joint Stock Company

Handsets and low churn drive forecast increase

Q3 results

Telecoms

23 November 2020

Price (GDR)

US$7.2

Market cap

US$1,440m

KZT429/US$

Net debt (KZTbn) at H120* excluding lease liabilities

54

Shares in issue

200m

Free float

25%

Code

KCEL

Exchanges

KASE, AIX, LSE

Share price performance

%

1m

3m

12m

Abs

15.2

23.1

33.3

Rel (local)

N/A

N/A

N/A

52-week high/low

US$7.2

US$5.2

Business description

Kcell Joint Stock Company (Kcell) is a mobile operator in Kazakhstan and a listed subsidiary of Kazakhtelecom (KT), a state-owned incumbent with a 70% share of the market. Consolidation is delivering dramatic improvements in the market and as a subsidiary of the dominant operator, Kcell is well positioned to benefit.

Next events

Q4 results

March 2021

Analyst

Dan Gardiner

+44 (0)20 3077 5700

Kcell Joint Stock Company is a research client of Edison Investment Research Limited

After a Q2 affected by COVID-19, Kcell’s revenue and profit growth accelerated sharply in Q3. Handset sales (+124% y-o-y to KZT11bn) were the main surprise (again), but there were encouraging trends in the services business also. Kcell posted its highest net additions in six years with churn remaining close to record lows. These trends are further evidence of an improving market and the success of Kcell’s new strategy in our view. We raise our FY20 EPS forecasts by 23% to KZT120.

Year end

Revenue (KZTbn)

Adj EBITDA* (KZTbn)

Adj EPS* (KZT)

EV/adj EBITDA* (x)

P/E
(x)

FCF yield
(%)

Div yield
(%)

12/19

156.7

63.5

103

10.6

30.1

2.5

1.0

12/20e

170.5

70.9

120

9.5

25.8

4.7

1.5

12/21e

172.1

73.1

140

9.2

22.0

5.8

3.6

12/22e

178.9

75.0

148

8.9

20.8

6.0

4.3

Note: *EBITDA and EPS are adjusted to exclude amortisation of acquired intangibles and exceptional items.

A recovery in growth…

Kcell saw headline sales (KZT46.8bn) accelerate from 2.0% y-o-y in Q2 to 13.9% in Q3. Much of this reflected a surge in handset growth, up 84% q-o-q and 124% yoy predominantly driven by corporate sales. Service revenue trends also recovered. Adjusting for bulk SMS sales, service revenue rose 2% y-o-y (vs 1.6% in Q2) as low churn (29.5%) resulted in Kcell’s highest subscriber growth in six years. ARPU growth, while still not back to pre-COVID-19 levels, recovered to 6.3% y-o-y.

…plus cost control equals rapid profit growth

The mix shift towards handsets saw gross margins (pre-depreciation) fall marginally year-on-year to 50.9%. However, with opex and depreciation largely flat sequentially and year-on-year, 38% of incremental sales fell straight through to profits. Underlying EBIT rose 20% y-o-y and a lower tax rate (16%) helped adjusted EPS grow 49%. A large working capital outflow was partially offset by low cash capex (6% of sales) to result in free cash flow (FCF) of KZT8.1bn, up 13% y-o-y and a margin of 17.3% (Exhibit 1).

Raising forecasts

Kcell introduced FY20 guidance of ‘high single digits’ (indicated to be 8–10%) for sales growth and EBITDA, implying 10% EBITDA growth for Q4 at the mid-point. We lift our FY20 EPS forecast 23% to KZT120. Assuming at least some of the handset strength and lower churn continues, our FY21 and FY22 EPS forecasts rise by 16% and 9% respectively. A modest lift to capex limits the increase in FY21 and FY22 FCF to 6% and 4%, respectively.

Valuation: A justified premium

Kcell appears to have weathered the worst of the storm, with the underlying improving trends in the market becoming visible once more. Its shares are up 20% ytd, reflecting a resilient financial performance during this period of uncertainty. At $7.2 they imply an FY22 P/E of 20.8x, a premium to its emerging market telco peers that we believe could be justified by the scope for further forecast upgrades driven by the recovery in the market and synergies within the enlarged KT group.

Q3 analysis and forecast changes

Handsets outperform (again)

A surge in handset sales (up 84% q-o-q and 124% y-o-y) to KZT11bn (23.5% of sales) was the big surprise of Q3. In Resilience and consolidation benefits expected we highlighted concerns that COVID-19 lockdowns would see sharp falls in phone sales; instead the opposite happened. Kcell posted near record handset revenue growth in Q2 (62% y-o-y) and then doubled that rate of growth in Q3 (see Exhibit 1 and 2), citing pent up corporate and Ministry of Education sales (revenues include tablet and accessory sales) as the driver of this performance. This rate of growth is unlikely to be sustainable. Kcell acknowledges that absolute volumes may decline in H121 due to seasonality and as the iPhone 12 product cycle matures. Nevertheless, it believes it has expanded its retail share during the lockdown and that most of these gains are sustainable.

Exhibit 1: Financial performance in Q3 (year-on-year)

KZTbn

Q3

Change

2019

2020

Absolute

%

Revenue

Core service revenue

35.1

35.8

0.7

2.0

Handset

4.9

11.0

6.1

123.8

Core revenue

40.0

46.8

6.8

16.9

Off-net bulk SMS

1.1

-

(1.1)

(100.0)

Total

41.1

46.8

5.7

13.9

Adjusted EBITDA

18.2

20.5

2.3

12.9

Margin (%)

44.2

43.8

(0.4)

(0.9)

Adjusted EBIT

10.5

12.6

2.1

19.7

Margin (%)

26.3

26.9

0.6

2.4

EPS (KZT/share)

28.9

43.2

14.2

49.1

Cash flow from operations (CFFO)

13.2

10.9

(2.2)

(17.0)

Capex

(6.0)

(2.8)

3.2

(52.9)

FCF

7.2

8.1

0.9

13.1

Margin (%)

17.4

17.3

Source: Kcell

Kcell’s success here bodes well for the future of its service business. Typically, handsets are seen as a low-margin transactional sale (Kcell reported a 27% EBITDA margin on incremental handset revenue in Q3). However, the company estimates that 90% of the customers buying handsets through its channel are on (at least) 18-month subscription bundle packages that are highly profitable and low churn. If Kcell can continue to attract customers through this channel it bodes well for the quality of its customer mix in the long term.

Exhibit 2: Handset revenue during COVID-19 has substantially outstripped our previous forecasts

Exhibit 3: Churn is consistently lower since the arrival of new management and change in market structure

Source: Kcell, Edison Investment Research Note: *Annualised.

Source: Kcell data, Edison Investment Research

Exhibit 2: Handset revenue during COVID-19 has substantially outstripped our previous forecasts

Source: Kcell, Edison Investment Research Note: *Annualised.

Exhibit 3: Churn is consistently lower since the arrival of new management and change in market structure

Source: Kcell data, Edison Investment Research

Encouraging service revenue trends

Following a Q2 where the impact of COVID-19 on interconnection and usage resulted in core service revenue growth turning negative, Q3 saw a return to growth. Adjusting for bulk SMS sales (which Kcell stopped in Q220), service revenue rose 2% y-o-y in Q3, still below recent trends but an improvement in a tough market (Kazakhstan was still in lockdown in July). Another quarter of low churn (29.5%) helped Kcell post its highest customer growth for six years. As Exhibit 3 highlights, the last two years have seen Kcell’s churn fall substantially, reflecting the change in market structure in our view. If sustained, this trend bodes well for both future growth and profitability.

Reported average revenue per user (ARPU) growth ticked up slightly (from 5.2% in Q2 to 6.3% in Q3) but is still not back to pre-COVID-19 levels (see Exhibit 4). We believe this largely reflects a c 3pp drag due to the decline in bulk SMS revenue. The underlying pricing dynamics continue to look healthy: voice and data trends are unchanged and the proportion of the subscriber base on more lucrative bundles rose 3.5pps q-o-q to 60.5%. As the impact of the decline in bulk SMS annualises (Q221) and the economy continues to recover, we believe Kcell’s ARPU growth (and by extension service revenue growth) should accelerate.

Exhibit 4: Service revenue (SR) and ARPU growth recovered but are still not back to pre COVID-19 levels

Exhibit 5: Service revenue and subscriber additions vs Veon (Beeline)

Source: Kcell data, Edison Investment Research. Note: *Annualised.

Source: Kcell data, Edison Investment Research

Exhibit 4: Service revenue (SR) and ARPU growth recovered but are still not back to pre COVID-19 levels

Source: Kcell data, Edison Investment Research. Note: *Annualised.

Exhibit 5: Service revenue and subscriber additions vs Veon (Beeline)

Source: Kcell data, Edison Investment Research

Closing the gap on its peers

Since arriving in late 2018, Kcell’s new management have primarily focused on improving its profitability and the quality of its subscriber base. EBITDA margins are up 9pp ytd vs 2018 and the company has returned to growth. Exhibit 5 shows it is steadily closing the gap between its service revenue growth rate and that of its nearest peer Veon and is now matching it in customer additions.

To further lift growth rates and close the gap with Veon, we believe Kcell will need to accelerate investment in 4G roll out (in co-ordination with its sister mobile companies Tele2 and Altel). Coverage by population currently stands at 64.8%, and expanding it will improve Kcell’s competitive position and drive traffic growth of its existing customers. The company highlighted its low net debt to EBITDA ratio on the recent call, suggesting it has plenty of scope to raise investment if needed.

Raising FY20 and long-term forecasts

Kcell states that visibility is improving. It introduced FY20 guidance of ‘high single digits’ (8–10%) for revenue growth and EBITDA. Implying 6.5% and 10% revenue and EBITDA growth respectively in Q4, lower than Q3 trends, this guidance appears conservative. We lift our FY20 adjusted EPS forecast by 23% to KZT120, to reflect the outperformance in Q3. Our forecasts are slightly above guidance, implying 11.6% y-o-y growth in underlying EBITDA.

After two quarters of outperformance in handsets, we now consider that Kcell’s share gains here are sustainable. Factoring in lower churn (40% vs 45% previously) leads us to marginally raise our customer numbers (7.7m to 8.0m in FY22) and our FY21 and FY22 EPS forecasts by 15.8% and 8.8% respectively (see Exhibit 6). We raise our capital expenditure forecast for FY21 and FY22 from 14% of sales to 15% to reflect a potential acceleration in 4G spending.

Exhibit 6: Changes to forecasts

KZTbn

FY20e

FY21e

FY22e

Old

New

%

Old

New

%

Old

New

%

Revenue

Core service revenue

128.0

136.7

6.8

135.3

141.3

4.5

145.8

147.8

1.4

Handset

25.8

32.5

25.9

24.5

30.8

25.9

24.7

31.1

25.9

Core revenue

153.8

169.1

10.0

159.8

172.1

7.8

170.5

178.9

4.9

Off-net bulk SMS

1.4

1.4

-

-

-

-

-

Total

155.1

170.5

9.9

159.8

172.1

7.8

170.5

178.9

4.9

Adjusted EBITDA

64.8

70.9

9.4

68.4

73.1

6.9

71.9

75.0

4.3

Margin (%)

41.8

41.6

42.8

42.5

42.2

41.9

Adjusted EBIT

35.3

40.8

15.6

40.9

45.6

11.6

44.9

48.0

6.9

Margin (%)

22.7

23.9

25.6

26.5

26.3

26.8

EPS (KZT/share)

97.6

119.6

22.6

121.3

140.4

15.8

136.3

148.3

8.8

CFFO

52.6

48.7

(7.5)

56.1

61.5

9.5

59.4

63.7

7.2

Capex

(19.8)

(19.4)

(22.4)

(25.8)

15.5

(23.9)

(26.8)

12.4

FCF

32.9

29.3

(10.9)

33.8

35.7

5.6

35.5

36.9

3.8

Margin (%)

21.2

17.2

21.1

20.7

20.8

20.6

Source: Edison Investment Research

Exhibit 7: Financial summary

KZTbn

2017

2018

2019

2020e

2021e

2022e

Year end 31 December

IFRS

IFRS

IFRS

IFRS

IFRS

IFRS

INCOME STATEMENT

Revenue

 

 

147.5

149.7

156.7

170.5

172.1

178.9

Cost of Sales

(67.0)

(72.8)

(79.2)

(85.9)

(86.1)

(89.5)

Gross Profit

80.5

76.9

77.4

84.5

86.1

89.5

Adjusted EBITDA

 

 

57.6

50.9

63.5

70.9

73.1

75.0

Operating Profit (before amort. and except).

 

34.5

24.5

33.4

40.8

45.6

48.0

Amortisation of acquired intangibles

0.0

0.0

0.0

0.0

0.0

0.0

Exceptionals

(2.7)

(3.4)

(10.4)

(0.4)

0.0

0.0

Share-based payments

0.0

0.0

0.0

0.0

0.0

0.0

Reported operating profit

31.8

21.1

23.0

40.3

45.6

48.0

Net Interest

(9.4)

(8.9)

(10.1)

(9.7)

(10.5)

(10.0)

Joint ventures & associates (post tax)

0.0

0.0

0.0

0.0

0.0

0.0

Exceptionals

0.0

0.1

(0.1)

1.3

0.0

0.0

Profit Before Tax (norm)

 

 

25.1

15.6

23.3

31.1

35.1

38.0

Profit Before Tax (reported)

 

 

22.4

12.3

12.9

32.0

35.1

38.0

Reported tax

(8.6)

(3.7)

(2.8)

(7.2)

(7.0)

(8.4)

Profit After Tax (norm)

16.5

11.8

20.6

23.9

28.1

29.7

Profit After Tax (reported)

13.8

8.5

10.1

24.8

28.1

29.7

Minority interests

0

0

0

0

0

0

Discontinued operations

0

0

0

0

0

0

Net income (normalised)

16.5

11.8

20.6

23.9

28.1

29.7

Net income (reported)

13.8

8.5

10.1

24.8

28.1

29.7

Average Number of Shares Outstanding (m)

200

200

200

200

200

200

EPS – basic normalised (KZT)

 

 

82

59

103

120

140

148

EPS – diluted normalised (KZT)

 

 

69

43

51

124

140

148

EPS – basic reported (KZT)

 

 

69

43

51

124

140

148

Dividend per share (KZT)

58

59

30

45

110

134

Revenue growth (%)

4.6

8.8

1.0

3.9

Gross Margin (%)

54.6

51.4

49.4

49.6

50.0

50.0

EBITDA Margin (%)

39.1

34.0

40.6

41.6

42.5

41.9

Normalised Operating Margin (%)

23.4

16.2

21.3

23.9

26.5

26.8

BALANCE SHEET

Fixed Assets

 

 

138.6

132.7

147.1

133.0

131.3

131.2

Intangible Assets

43.1

40.1

38.8

32.8

32.6

32.6

Tangible Assets

93.7

88.4

82.3

73.5

72.0

71.8

Investments & other

1.9

4.2

26.0

26.7

26.7

26.7

Current Assets

 

 

42.3

34.4

44.2

95.4

72.7

83.8

Stocks

3.4

4.7

6.6

8.9

8.5

8.6

Debtors

26.2

23.6

23.8

21.6

23.1

24.0

Cash & cash equivalents

12.7

6.0

8.8

45.8

22.1

32.2

Other

0.0

0.0

5.0

19.0

19.0

19.0

Current Liabilities

 

 

(87.2)

(81.2)

(39.4)

(39.2)

(20.5)

(20.9)

Creditors

(28.8)

(29.4)

(21.2)

(12.4)

(12.5)

(12.8)

Tax and social security

0.0

0.0

0.0

0.0

0.0

0.0

Short term borrowings

(58.4)

(51.8)

(6.4)

(22.7)

(4.0)

(4.0)

Other

0.0

0.0

(11.8)

(4.1)

(4.1)

(4.1)

Long Term Liabilities

 

 

(18.0)

(17.8)

(80.4)

(102.1)

(90.3)

(98.0)

Long term borrowings

(12.0)

(14.9)

(55.5)

(70.0)

(70.0)

(70.0)

Other long-term liabilities

(6.0)

(2.9)

(24.8)

(32.1)

(20.3)

(28.0)

Net Assets

 

 

75.6

68.1

71.6

87.1

93.2

96.1

Minority interests

0.0

0.0

0.0

0.0

0.0

0.0

Shareholders' equity

 

 

75.6

68.1

71.6

87.1

93.2

96.1

CASH FLOW

Op Cash Flow before WC and tax

57.6

50.9

63.5

70.9

73.1

75.0

Working capital

(13.8)

(20.6)

(19.3)

(21.4)

(1.1)

(1.3)

Exceptional & other

12.3

10.9

0.8

23.3

14.0

16.7

Tax

(12.9)

(5.4)

(2.2)

(14.4)

(14.0)

(16.7)

Net operating cash flow

 

 

43.2

35.8

42.8

58.4

72.0

73.7

Capex

(22.6)

(19.3)

(18.2)

(19.4)

(25.8)

(26.8)

Acquisitions/disposals

0.0

0.0

0.0

0.0

0.0

0.0

Net interest

(9.7)

(8.3)

(9.4)

(9.7)

(10.5)

(10.0)

Equity financing

0.0

0.0

0.0

0.0

0.0

0.0

Dividends

(11.7)

(11.7)

(6.0)

(9.0)

(22.0)

(26.7)

Other

0.0

0.0

0.0

0.0

0.0

0.0

Net Cash Flow

(0.8)

(3.4)

9.3

20.3

13.7

10.1

Opening net debt/(cash)

 

 

56.9

57.8

60.7

53.1

32.8

19.1

FX

(0.0)

0.1

(0.1)

0.0

0.0

0.0

Other non-cash movements

(0.0)

0.3

(1.6)

0.0

0.0

0.0

Closing net debt/(cash)

 

 

57.8

60.7

53.1

32.8

19.1

9.0

Source: Company data, Edison Investment Research

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Frankfurt +49 (0)69 78 8076 960

Schumannstrasse 34b

60325 Frankfurt

Germany

London +44 (0)20 3077 5700

280 High Holborn

London, WC1V 7EE

United Kingdom

New York +1 646 653 7026

1185 Avenue of the Americas

3rd Floor, New York, NY 10036

United States of America

Sydney +61 (0)2 8249 8342

Level 4, Office 1205

95 Pitt Street, Sydney

NSW 2000, Australia

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