S&P: South Africa-Based Telecommunications Service Provider Telkom SA SOC Ltd. 'BBB-' Rating Affirmed; Outlook Stable
The affirmation takes into account that the positive results from Telkom's changed business model, characterized by growing representation of broadband, and its information and communication technology (ICT) solutions business haveoffset the structural decline of the fixed-voice business segment. This is also complemented by the phased integration of Business Connexion (BCX), strong drive to reduce operating costs, and the signifcant reduction of the mobile business' losses. This has improved Telkom's operating cash flow, whichhas allowed the company to fund capital expenditure (capex), while maintaininga positive free operating cash flow profile in fiscal 2016 (ended March 31). As a result of its financial performance, Telkom lifted its dividend moratorium by remunerating its shareholders with about 60% of net income (South African rand [ZAR] 1.4 billion [$100 million]).
South Africa (foreign currency BBB-/Negative/A-3; local currency BBB+/Negative/A-2) is currently up against economic growth concerns. S&P Global Ratings' latest forecasts are that South Africa's GDP will grow by 0.6%in 2016 and 1.5% in 2017. Telkom's strategy is grounded on servicing a strong and mid - to upper-income consumer and the private sector, both of which have registered low confidence metrics. Our base-case forecasts for Telkom incorporate the company's cautious guidance of growth and tapering of capital intensity (such as capex as a percentage of revenue) to take into account our medium-term view of its operating environment. Under such a scenario, in relation to the S&P Global Ratings-adjusted debt (average of ZAR6 billion), Telkom maintains a conservative capital structure in which adjusted debt to EBITDA is no higher than 1x. In addition, under the same economic conditions, we believe that Telkom would have solid fluidity and we continue to assess itsliquidity position as adequate.
We regard Telkom as a government-related entity (GRE) due to the government's ownership and statutory framework under which Telkom operates. However, we think that there is a low likelihood that the South African government would provide timely and sufficient extraordinary support to the company if needed. We base our assessment on Telkom's:
Limited link with the government. The state owns 39.3% and intervention inTelkom has abated, allowing the board and the management scope to drive strategy. In addition the government's share of the Telkom dividend is insignificant to the government's ZAR1 trillion tax revenue. Lastly, the government has renewed its exemptions on Telkom from rules and regulationsthat would normally govern GREs that have an affiliated statutory framework with the government.
Limited importance to the government because we believe Telkom operates asan independent, profit-seeking company in a competitive environment. Also Telkom's operations can be easily substituted by other forms of communications such as those offered by mobile network operators.
Our assessment of Telkom's business risk profile as fair reflects the negativestructural change of its fixed-line voice segment, for which the company is a market leader. Also, Telkom's mobile business' market share is minor at around1% compared with leaders such as Vodacom Group Ltd. and MTN Group Ltd., which both enjoy a market share in the mid 40%. However, we believe that the increasing representation of Telkom's broadband and ICT solutions businesses is providing corrective measures. In addition we recognize the high capex phase in its fiber and long-term evolution (LTE) rollout that is enabling growth in the broadband business in particular. Furthermore, the reduction in the mobile business' losses and cost-cutting initiatives, which included voluntary severance and early retirement packages, has improved the company's operating efficiency.
We anticipate that Telkom's adjusted debt to EBITDA will be lower than 1x by awide margin. We anticipate that funds from operations (FFO) to debt to exceed 100% in 2017 and 2018. With the reinstating of a modest dividend growth policy, we now take note of Telkom's level of discretionary cash flow (DCF). We assess that DCF in the forecast years will be positive and therefore assessthe financial risk profile as modest.
In our base case, we assume:
Low-single-digit growth in revenue.
Reported EBITDA averaging 24%, which is in line with company's guidance band.
Capex of 17% of revenue in fiscal 2017, trending down to 15% in the subseqent year.
Dividend at a minimum of 50% of net income.
Based on these assumptions, we arrive at the following credit measures for 2017-2018:
Adjusted debt to EBITDA of around 0.6x.
FFO to debt in excess of 100%.
Positive discretionary cash flow, with 18% relative to adjusted debt.
We assess Telkom's liquidity as adequate. We anticipate that Telkom's solid cash flows and available facilities will exceed its commitments and obligations by more than 1.2x over the 12 months started June 30, 2016.
For the 12 months started June 30, 2016, we calculate the following principal liquidity sources:
Unrestricted cash of around ZAR2.6 billion. We also take a view that Telkom has a sizable amount of marketable securities, but we do not include this in our calculation as we rely on readily available cash.
Our expectation of cash FFO of around ZAR8 billion.
Undrawn medium-term committed credit facilities of ZAR4 billion.
For the same period, we calculate the following principal liquidity uses:
Debt maturities of ZAR520 million.
Capex of 17% of revenues.
A dividend payout ratio of 50% of net income.
No planned acquisition or mergers.
Based on our assessment of Telkom's limited link with and limited importance to the South African government, the rating on Telkom could be higher than theforeign currency rating on South Africa. We limit the differential to one notch. Due to the negative outlook on the sovereign rating, we conducted a stress test on Telkom to assess the company's resilience under a hypothetical sovereign default scenario.
We determined that Telkom could withstand a hypothetical sovereign default scenario mainly on the assumption of a stress on earnings (20% haircut) and factored in a 50% devaluation of the South African rand.
The stable outlook reflects our view that Telkom's stand-alone credit profile can withstand the current pressure on South Africa's creditworthiness. We alsotake into account the company's limited link with and limited importance to the government. Within the current economic environment, we project that Telkom's earnings, capex commitments, and dividend policy will be in line withthe current rating over the next two years. We also take into consideration that its business risk profile is now insulated from erosion of the fixed-linevoice business due to the representation of broadband and ICT solutions business from increased fiber and LTE rollout as well as through the phased integration of BCX, respectively. We expect Telkom's adjusted leverage to remain below 1x and FFO to debt well above 100%.
We could lower the rating on Telkom if there is a multiple-notch downgrade of South Africa. In addition, on a stand-alone basis, we could lower the rating if adjusted leverage was above 2x. This could occur if there is poor executionof the BCX integration, there is weak traction in the broadband business, and mobile earnings fail to maintain a break-even level at a minimum. We could also lower the rating if cash flows weaken considerably if discretionary cash flow to debt were to fall below 10% as Telkom resumes its dividend policy.
An upgrade of Telkom is unlikely over the medium term due to the economic pressures in South Africa and the negative outlook on the sovereign rating.