TEXT-S&P cuts Telkom to 'BBB-'; outlook stable
(The following statement was released by the rating agency)
Dec 04 -
-- We think the continued decline in fixed line and losses in mobile will result in further profit erosion for South African telecommunications provider Telkom S.A. Ltd. (Telkom).
-- In addition, sustained network investment could result in very weak free cash flow generation.
-- We are lowering our long-term rating on Telkom to 'BBB-' from 'BBB'.
-- The stable outlook reflects our expectations of a low- to mid-single-digit decline in sales from Telkom's core fixed-line business, gradual reduction of mobile operating losses, and maintenance of a solid capital structure over the next two years.
On Dec. 4, 2012, Standard & Poor's Ratings Services lowered its long-term corporate credit rating on South African telecommunications provider Telkom S.A. Ltd. (Telkom) to 'BBB-' from 'BBB'. The outlook is stable.
The downgrade reflects our expectations of Telkom's gradual and sustained weakening of operating performance. We believe that the likely steady revenue growth from its fixed-broadband and mobile services are unlikely to offset, over the next two years, the sharp downward trend in its core fixed-line voice revenues. We base our view on the ongoing fixed-to-mobile substitution trend and rising pricing pressures from mounting competition, as well as a likely reduction in leased line revenues resulting from mobile operators' increasing self-provisioning.
The downward trend in highly profitable fixed-line voice traffic, its high fixed-cost base and operating losses for mobile operations will likely further affect Telkom's profitability over the next two years. This, combined with a projected surge in capital expenditures, could result in sustained very weak free cash flow generation.
Overall, we project a low-single-digit total group revenue decline for Telkom in the fiscal years ending March 31, 2013, and March 31, 2014, and a further deterioration of its EBITDA margin to the 21%-23% range over the same period--a relatively weak level compared with peers--from 25% in the fiscal year ended March 31, 2012, and 27% in fiscal year ended March 31, 2011.
We continue to assess Telkom's business risk profile and governance and management as "fair" under our criteria.
Our assessment of Telkom's financial risk profile remains "modest" however, reflecting its robust operating cash flow generation and solid capital structure. Standard & Poor's-adjusted gross debt-to-EBITDA ratio was a moderate 1.3x on Sept. 30, 2012, which continues to support the ratings.
In our view, numerous changes in Telkom's top management and board in recent years may have delayed the implementation and execution of its strategic priorities, notably the buildout of its mobile operations and the material upgrade of fixed infrastructure.
We anticipate, however, that there will be a surge in capital expenditures between 2013 and 2015--potentially in excess of 20% of sales--as necessary to fund its network investment plans. Management indicated that capital expenditures could reach South African rand (ZAR)18 billion-ZAR21 billion over the period.
The higher capital expenditures are likely to depress Telkom's generation of free operating cash flow (FOCF), which may turn slightly negative over that period in our view. Nevertheless, in our baseline scenario, we do not project an increase of adjusted leverage above 1.5x, a level commensurate with our revised rating expectations.
The ratings on Telkom primarily reflect its strong leadership position in the country's fixed-line telecoms market, good growth prospects in the broadband market, our opinion of the company's robust operating cash flow generation, and its maintenance of a prudent financial policy.
The ratings are constrained, however, by the structural decline in Telkom's fixed-line voice traffic, ongoing access line losses, its high fixed-cost base, material risks associated with the future performance of the company's mobile telephony business, and increasing competition.
We assess Telkom's liquidity as "adequate," according to our criteria, based on the following elements as of Sept. 30, 2012:
-- ZAR564 million of cash on hand,
-- About ZAR4.3 billion of liquid short-term investments,
-- Roughly ZAR4.0 billion of undrawn committed credit facilities.
This, combined with Telkom's ZAR10 billion domestic medium-term note program, altogether provide Telkom with sound financial flexibility to cover:
-- An expected rise in network investments stemming from the mobile network rollout and the launch of a multi-year material upgrade of the fixed infrastructure.
-- Short-term debt of ZAR1.4 billion, mostly consisting of commercial paper.
-- Our anticipation of the resumption of a modest dividend distribution beyond 2013, after the suspension of all shareholder returns for fiscal 2013.
Overall, we estimate Telkom's coverage of liquidity uses by available liquidity sources to be in excess of 1.5x for the 12 months to end-September 2013.
The next major debt maturity consists of the ZAR4.1 billion syndicated credit facilities, of which ZAR2.0 billion was drawn on Sept. 30, 2012. This facility is due in December 2013. We expect the company to proactively work on lengthening its debt maturity profile in the coming months. We also expect the company to continue to limit its overall exposure to foreign currency debt.
Some of Telkom's debt outstanding--including the ZAR2.5 billion bond issue (TL20)--carries financial maintenance covenants. For example, the company must maintain a leverage ratio (that the terms of the documentation define as net interest-bearing debt to the past 12 months of EBITDA) of not more than 3.0x and an interest coverage ratio (net of finance charges to the last 12 months of EBITDA) of not less than 3.5x. Furthermore, the syndicated credit facilities include a rating trigger that gives lenders the possibility to require repayment of amounts outstanding if the rating on Telkom falls to the speculative-grade category.
The stable outlook reflects our expectations of a low- to mid-single-digit decline in sales from Telkom's core fixed-line business, gradual reduction of mobile operating losses, and the maintenance of a solid capital structure and conservative financial policy over the next two years.
The planned surge in capital expenditures stands to depress Telkom's generation of free cash flow, which could be negative over 2013-2015. Nevertheless, we expect the group to preserve robust credit measures, with adjusted ratios of gross debt to EBITDA below 2.0x and FFO to debt at or above 45%, levels commensurate with the 'BBB-' rating.
Although unlikely in the next two years, we could further lower the ratings on Telkom in the event of a more significant weakening in the company's business risk profile than we currently anticipate, its inability to sustain positive FOCF over the medium term, or a durable decline in credit measures to levels not commensurate with the current rating.
We believe that ratings upside is unlikely in the next two years, given the continued strain on the fixed-line business, and uncertainties concerning Telkom's future business performance in domestic mobile activities.
Related Criteria And Research
All articles listed below are available on RatingsDirect on the Global Credit Portal.
-- Methodology: Business Risk/Financial Risk Matrix Expanded, Sept. 18, 2012
-- Principles Of Credit Ratings, Feb. 16, 2011
-- Key Credit Factors: Business And Financial Risks In The Global Telecommunication, Cable, And Satellite Broadcast Industry, Jan. 27, 2009
-- The Largest Operators Have The Most To Lose In Europe's Telecom Market, Nov. 7, 2012
Downgraded; CreditWatch/Outlook Action
Telkom S.A. Ltd.
Corporate Credit Rating BBB-/Stable/-- BBB/Negative/--
Senior Unsecured BBB- BBB