Hungary Magyar Telekom Q1 revenues, profit drop but do not disappoint (3)

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Revenues of Hungarian telecoms group Magyar Telekom were as expected in the first quarter of 2011, but its profits and EBITDA came in higher than the consensus forecasts in a Portfolio.hu poll, the company’s Q1 preliminary earnings report showed on Friday. The year-on-year decline in key results was caused by a number of factors. The question is which of these had the analysts incorporated into their models and which had been left out.

Over the past few days MTel was behaving like a defensive telco stock should have. Adjusting the share price for the dividend we see that it has been stably around 600 for more than two weeks now. And this is a commendable performance in a period when leading U.S. and western European stock indices can drop 3-5% in a matter of days. The question is whether this ‘waiting-for-a-miracle’ attitude had to do with today’s flash report or not.

Altogether, shareholders can be satisfied with MTel’s Q1 numbers. The rate of erosion in revenues has decreased, operating expenses are in tight control, the net debt ratio is at the lower end of the target range and based on the January-March performance of the group the management’s full-year objectives may even seem conservative. Of course, we need to remember that Q1 2010 was relatively weak, so the base effect is strong. We should not even ask for more from Mtel that is facing strong competition, a special levy and diminished orders from the government and corporates.

On an EV/EBITDA basis MTel remains cheaper than the shares of its closest sector peers. If the company manages to boost its free cash flow further in the coming quarters; analysts and shareholders can start visualising a lot higher dividend per share than the HUF 50 paid this year then the paper could become attractive also on a dividend basis.

Key items in the earnings report are the following:

• Much better profits than expected at first sight, with lots of “extras" (real estate sales, special tax, smaller deferred tax expense)
• Smaller rate of revenue decline at group level
• Revenue decrease larger in fixed-line segment, more moderate in mobile segment
• Macedonian unit under a lot of pressure, Montenegrin unit holding up slightly better
• Investments at low levels not seen since early 2008
• Operating expenses kept in close check
• Net debt ratio at the lower end of the target range
• 2011 guidance confirmed

Management sticks to earlier guidance

• Q1 results reflect slow economic recovery, but there are promising signs, such a rise in mobile traffic and migration moderated both in the fixed-line and mobile segments
• Revenues compared to the extremely weak first quarter of 2010 dropped 3.3%, while underlying EBITDA grew by 3.8% yr/yr
• Real estate sales in Hungary had a positive impact on results. Savings in employee-related and other operating expenses also helped profitability.
• Excluding the real estate sales, underlying EBITDA still increased by 1.5%
• Management reiterated its guidance, projecting a revenue decline of 3-5% and 4-6% underlying EBITDA decline for 2011. Intention to cut Capex by cc. 5% compared to last year’s spending remains.

Stronger than expected figures, but what had the analysts taken into consideration?

Magyar Telekom’s revenues came in very slightly below the consensus forecast in a Portfolio.hu poll, but from the EBITDA row down the Q1 numbers were much stronger than what the market expected. The difference stems partly from the fact that MTel sold several real estates in Q1 that improved its EBITDA by HUF 1.4 bn. From the operating level down another explanation of the difference is that the company applied strict cost control in employee-related and other operating expenses.

There is another extra impact on the net profit row, which the analysts may not have taken this into consideration. Income tax expense decreased from Q1 2010 to Q1 2011 as a combined result of lower profit before tax and the still enacted reduction of the Hungarian corporate tax rate from 19% to 10% effective from 2013. There are a number of expenses (e.g. depreciation, amortization, FX losses) which are recognized at a corporate tax rate of 19%, while the related deferred tax expense at 10%. As long as this difference between the current (19%) and future (10%) enacted tax rates exists, it results in lower deferred tax expense reducing the effective tax rate.

The levy imposed on the telecom sector is one of the negative impacts on the profit. MTel puts this down among other operating expenses and is booked every month as of 2011. The Q1 balance shows a HUF 6.3 bn cost on this row.

Comparing the Q1 numbers to the full-year guidance we can say the first three months were strong both in revenue and EBITDA terms. Based on this the management guidance for 2011 may seem conservative, but let’s not forget that the January-March period in 2010 was rather weak, so there is a strong base effect behind the Q1 2011 figures.

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