Operating performance still strong: Buy rating reiterated

MTN Nigeria sustained growth in earnings in Q3 as the telco firm reported double-digit growth in Revenue (up 12% y/y to N856.5 billion) on the back of growth in voice (+10.1% y/y) and data revenue (+35% y/y). Buoyed by the topline growth and the sub inflationary growth in Operating Expenses (up 6% y/y), Pre-tax Profit grew strongly, up 24% y/y to N212.0 billion in 9M 2019. EPS also grew 29% y/y to N7.29 in 9M 2019 from N5.63 in 9M 2018.

Considering MTN’s strong footing in the Nigerian telecoms market (market share of 37% as of September 2019) coupled with its aggressive efforts at retaining existing customers whilst also attracting new ones through improved technology, we believe the company is well-positioned to benefit from further growth in mobile and data penetration in Nigeria’s fast-growing telecommunications industry.

We have made minor revisions to our model. The overall impact is a marginal increase in our price target to N184.2/s from N182.6/s previously, hence we retain our BUY recommendation. Our revised target price implies an upside potential of 51% from the last closing price of N122.0/s. MTN is currently trading at a FY2019e P/E and EV/EBITDA of 12.3x and 4.2x respectively, a discount to EM peers average of 17.5x and 6.73x respectively. We arrived at our target price using Discounted Cash Flow (DCF) and Relative Valuation (RV), with a 60:40 weighting respectively.

Growth in Top line still impressive 

The double-digit growth in Revenue (up 12% y/y) was driven by growth in voice (+10.1% y/y to N629.1bn) and data revenue (+35% y/y to N162.3 billion).  Management noted that the growth in Voice Revenue was supported by an increase in subscriber base (up 0.1million q/q to 61.6mn), relatively stable tariffs and its targeted segment offerings.

Data Revenue growth, on the other hand, was supported by improved data subscribers (up 7.6% q/q to 22.3 million), downward adjustment in the prices of data bundles which boosted data volumes, greater data traffic (68.9% q/q in Q3 vs 67% q/q in Q2) and improved 4G coverage following the activation of 800MHz spectrum in Q2 2019. MTN Nigeria added 1.6 million smartphones to its network, which increased smartphone penetration for the firm to 41.7%.  We believe the improved share of Data Revenue (18% in Q3 2019 vs.15% in Q3 2018) reflects the efforts of management in optimising data Revenue.

Faster growth in data revenue to offset slowing momentum in voice Revenue  

The share of Voice Revenue, however, declined to 73% in 9M 2019 from 75% in 9M 2018. We believe this development reflects the evolving trends in the telecommunication sector- the growing use of social media platforms for communication. We believe the rising use of social networking sites particularly WhatsApp for communication will continue to reduce voice traffic with its attendant impact on voice Revenue. Consequently, we expect the growth in voice Revenue to moderate, driven further by lower voice prices as operators in the industry attempt to lure subscribers to make use of conventional airtime for calls.

Overall, we have revised slightly downwards our estimate for the growth in Voice Revenue to 7.5% (previously; 7.7%) in 2019e, which is still lower than growth of 18.7% y/y reported in 2018. We also estimate the contribution of Voice Revenue to overall Revenue will moderate to 73.4% (previously; 74.1%) in 2019e from 75.4% in 2018.

However, we believe the slowing momentum in Voice Revenue will be offset by faster growth in Non-Voice Revenue especially mobile data and Mobile Financial Services (MFS). Rising smartphone penetration along with increasing mobile broadband penetration, improving network quality and attractive data offerings, should spur a rapid growth in data usage and in turn improve Data Revenue. Following the roll-out of 4G+ across Lagos, Abuja and Port Harcourt, management disclosed that 4G coverage is at over 35% in 64 cities in Nigeria.  We believe the 4G+ which runs on 4G LTE technology will support accretion in data subscribers and accelerate growth in Data Revenue over the medium to long term.

We highlight that the Minister of Communications and Digital Economy, Isa Pantami, recently directed the Management of the Nigerian Communications Commission (NCC) to re-evaluate the unauthorised deduction of data by network providers and review the high data prices charged by operators. Although the mobile network operators (MNOs) are yet to respond, we do not expect a significant reduction in data prices given that they have already reviewed downwards their prices for data bundles. Our survey shows that consumers paid lower prices in Q3-19 compared to Q1-19 for the same data bundle. MTN, for instance, slashed the price of 2GB monthly data plan from N2, 000 to N1,200 currently. Hence, we do not foresee significant decline in data prices in Q4 2019.

We have revised upwards our estimate for growth in data Revenue to 31% from 27% previously in 2019e and expect that the contribution of data Revenue to overall Revenue will improve to 18.9% from 15.9% in 2018. All in, we project FY 2019 Revenue of N1.15trn, translating to a growth of 10.4% when compared with FY 2018.

First time adoption of IFRS 16 drives moderation in Network Operating Costs 

Direct Network Operating Costs declined 22% y/y to N117.9bn owing to the marked decline in BTS (base transceiver station) leasing cost. Management however noted that the marked decline in Network Operating Costs was on the back of first-time adoption of IFRS 16- which required the reclassification of the Interest expenses associated with BTS leasing cost as part of Finance Cost. Supported by the moderation in Direct Network Operating Costs, Profit after direct costs grew (+26% y/y to N678.5bn).

MTN Nigeria reported a 39% y/y growth in EBITDA and EBITDA margin of 53.7% under IFRS 16, which is the new reporting standard the group has adopted. However, on an IAS 17 basis (the old reporting standard), the EBITDA margin grew 1.5ppts y/y to 44.7% (9M 2018; 43.2%), driven by the growth in Revenue and sub-inflationary growth in Operating Expenses (+9.3% y/y based on IAS 17). We like the sub inflationary growth in OPEX, reflecting efficiency in cost management. EBITDA (based on IAS 17) grew 16% y/y to N382.5 billion in 9M 2019 from N330.2bn in 9M 2018. We have left our FY 2019e EBITDA margin unchanged at 54%.

Initial adoption of IFRS 16 masks impact of improved debt mix on Finance Cost   

Net Finance Cost grew 73% y/y to N48.6bn owing to an increase in Finance Cost (+73% y/y to N91.9 billion) amidst a marginal decline in Finance Income (down 4% y/y to N17.7 billion). The surge in Finance Cost was due to a first time Interest Expense of N51.2 billion incurred on Leases in 9M 2019- Again, we note that this was due to the adoption of IFRS 16 which required the classification of Interest Expense on leases (previously classified as part of Direct Network Operating Cost) as part of Finance Cost. Excluding this item, Finance Cost would have moderated by 23% y/y to N40.7bn which would have reflected the improvement in its debt mix. Long term debt now accounts for 80% (compared to 18% in FY 2018) of total debt. Meanwhile, the mild decline in Finance Income was due to lower Interest Income on bank deposits (down 12% y/y despite the increase in cash from N53bn in FY 2018 to N102 billion as of 9M 2019) – we think this is likely due to the moderation in fixed deposit rates given lower yields in 2019 when compared to 2018.

We have revised our estimates for Finance Cost upwards in line with the marked increase observed in 9M 2019. Hence, we project Finance Cost of N121.9bn in 2019e. Our estimate for Finance Income in 2019 has been reviewed upwards to N23.4bn from N20.5bn previously, considering the increase in the firm’s cash balance in Q3.

Top line growth, cost efficiencies to buoy Profitability   

Pre-tax Profit grew strongly, up 24% y/y to N212.0bn in 9M 2019 from N171.0bn in 9M 2018. A lower effective tax rate of 30% in 9M 2019 compared with 33% in 9M 2018 supported the higher growth in Profit after tax (up 29% to N148.3bn in 9M 2019). EPS also grew 29% y/y to N7.29 in 9M 2019 from N5.63 in 9M 2018.

Based on the revisions to our Revenue, Cost and Net Finance Cost, we have reviewed upwards our FY 2019e Pre-tax profit to N288.3bn (previously; N283bn), representing a growth of 30% when compared to N221bn in FY 2018. Our PAT forecast of N201.8bn translates to an EPS of N9.9 in 2019e. The firm declared an interim dividend of N2.95/s (a pay-out ratio of 60.7% based on H1 2019 EPS of N4.92).

Considering management guidance of historical pay-out of c.80%, we project a final dividend of N4.95, bringing FY 2019 DPS to N7.9.

Valuation

We have revised our price target slightly upwards to N184.2/s from N182.6/s previously, hence we maintain our BUY recommendation. Our target price his implies 51% potential upside from the last closing price of N122.0/s on 8 November. We arrived at our target price using a Discounted Cash Flow (DCF) and Relative Valuation methods, assigning a weighting of 60:40.  Key inputs into our model include a riskfree rate of 13.7%, market risk premium of 6.5% and an adjusted beta of 0.9.

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