We recommend a HOLD on Safaricom. The counter is currently trading at a P/E multiple of 17.50x (at a price of KES 27.65, as at 9th August 2019). The company is a market leader in the telecommunications industry with a market share of 62.4% (1Q2019) of total mobile subscriptions. This represents a 36.3% market lead over its closest competitor Airtel Kenya. The market share gap between Safaricom and its competitors has been supported by the company’s heavy CAPEX spend over the years. Mobile data and M-PESA continue to be a key revenue drivers for Safaricom. The company has continued to leverage on the success of MPESA with new initiatives being based on the money transfer platform. We also note that the company is also pursuing opportunities outside Kenya. For instance, Safaricom is in talks with the Ethiopian government to introduce M-PESA in Ethiopia. In spite of the rising competitive and regulatory pressure (anticipated regulations based on the dominance study) we remain optimistic that the company will remain competitive. Furthermore, even with the recent increase in excise taxes (on mobile money transfer services, telephone and data services), we opine that subscription numbers will not be significantly affected owing to the high costs of switching to other networks. The large M-PESA ecosystem (agent network, customers, business vendors…) coupled with better coverage and reliability will deter users from shifting to other networks. A key risk we see with the MPESA ecosystem is the proposal by CA to enhance and extend the mobile interoperability. This may see the introduction agent to agent interoperability. This coupled with the current wallet to wallet interoperability may help smaller operators grow their ecosystems much faster. Agent to agent interoperability will likely require lengthy and wide consultations to implement and thus will only be a possibility in the medium to long term.
FY2019 Results commentary:
The company’s after tax profits grew by 14.7% y/y in FY2019 to KES 63.4 billion (FY2018: KES 55.3 billion). See a breakdown of the results here: The revenue performance from the different mobile segments was a mixed bag. On one hand, MPESA delivered growth but on the other hand, the legacy business segments (Voice, SMS and mobile data) significantly slowed down.
The decline in voice and SMS is not unique to Safaricom. Globally these segments have been commoditized, which means that cheaper pricing is only way to grow usage. In the messaging segment cheaper and richer alternatives in the form of over the top applications (such as Whatsapp) are preferred by users. OTT players have also contributed to the decline of the telcos’ share of international voice traffic. We expect the company to rely more on promotional activities, personal offerings and blended offers to grow usage in these segments.
We opine that margin preservation will be key in these segments. This can be achieved by leveraging more efficient technologies. For instance voice over LTE which uses LTE network for voice calls can also be used to deliver voice traffic more efficiently. Similar technologies (such as Rich Communication Services) can also be used to augment the short messaging services. We do note however that the impact of these technologies may only be in the long term due to the slow adoption rates (chicken and egg problem). Therefore in the short to medium term, we expect margin pressure on these segments.
We believe the company will still try to improve the affordability of data bundles. For instance, the company is now offering free (based on quota) YouTube access on its All in one bundle. This means the yields are likely to decline. Margin preservation for the mobile data segment can also be achieved through leveraging of more efficient technologies for instance, by shifting more traffic to the LTE network (accelerating the use of 4G through reducing cost of smartphone ownership-reduce 4G handset cost and increase affordability of data bundles), data caching and peering (this would help them lower international bandwidth costs).
Growth in MPESA revenue was supported by a bigger MPESA ecosystem (products, agents, customers). MPESA revenue profile has continued to shift reflecting a preference for more transactions that are done within the MPESA ecosystem (fewer withdrawals). In FY2019 new business and P2P accounted for 61.6% up from 52.6% in FY2016. Over the same period, withdrawals accounted for 38.4% down from 47.4% in FY2016. As a result of the higher proportion of revenue from the new business and P2P which the company does not pay commissions on, MPESA revenue contribution margin has improved from 64.6% in FY2016 to 70.3% in FY2019. We believe this shift is more sustainable (there’s sustainability in revenues and margin improvement). The company’s partnership with Equity bank will enable MPESA expansion to other countries. This will further boost revenues for the company. Although MPESA revenues seem resilient, the uncertain regulatory environment is a key risk. We expect the company’s continuous innovation and investments in partnerships will continue delivering growth.
MPESA has also contributed significantly to cost containment through the airtime recharges done through MPESA. We believe that airtime recharges through MPESA and improvements in the revenue profile via MPESA have partly contributed to the decline in the direct cost intensity from 40.6% in FY2012 to 28.6% in FY2019. Cost containment has also been achieved through economies of scale (e.g. better rates for maintenance of the passive and active network) and shift from leased fibre network to its own fibre network. We expect even more cost savings from investments in more efficient technologies such as Tube star base stations and 500G network.