2023-08-29 12:43:36 ET
Summary
- Q2 earnings for TIM S.A. showed impressive performance, with net revenue increasing by 9% and EBITDA increasing by 17%.
- TIM outperformed its largest competitor, Telefonica, in Q2, with faster revenue growth and a higher OIBDA margin.
- Valuation signals for TIM are improving, with revenue multiples closing in on the mean and profitability multiples below sector averages.
I am revisiting my Q1 thesis on TIM S.A. (TIMB) in light of Q2 earnings.
Reflecting on my Q1 analysis, I rated TIM a hold and felt that upside and downside potential were balanced. On the upside, Q1 mobile revenue grew double digits while the EBITDA margin improved even faster. In addition, management promised $4.5 billion in synergy value alongside organic growth. TIM also has the cash flow to maintain its dividend at current rates. Also, the quant rating was a buy on the back of strong momentum and profitability.
On the downside, Q1 performance decelerated on nearly every line from Q4 2022. Not only did it decelerate, but management ignored the topic throughout the earnings call. Second, TIM's deceleration was opposite the trend from its largest competitor, Telefonica, which grew quarter over quarter. Lastly, valuation multiples related to revenue were overinflated.
Since my last analysis, TIM's share price has been essentially flat. However, Q2 earnings were a marked improvement over Q1, with ARPU and profitability especially compelling. TIM also had a much better quarter than Telefonica, and valuation multiples are more compelling.
In my opinion, the upside potential for TIM remains while downside risks have started to moderate. Valuation signals are also becoming more compelling. With all of that in mind, I raise my rating from Hold to Buy and recommend investors enter the stock.
Q2 Performance Was Impressive
TIM had a really impressive 2nd quarter after declining into the 1st quarter. Net revenue increased 9%, and EBITDA increased nearly double at 17%, with a margin improvement of over 3 percentage points to 50%.
Q2 Revenue and EBITDA (TIMB Investor Relations)
Sequentially, TIM reversed the trend that had me concerned about their business. Quarter-over-quarter performance increased across the income statement. With revenue up and expenses down, EBITDA improved by double digits. This was also the first quarter where we saw expenses without the temporary service agreement from Oi. Management commented in the earnings call that while EBITDA will fluctuate across the year, they believe the higher margin is sustainable driven by synergy benefit.
Q2 Sequential Performance (TIMB Investor Relations)
On the rate side, ARPU grew 13% combined to record levels across postpaid and prepaid. ARPU growth significantly outpaced Brazil's inflation slightly worse, central-bank chief says , which has been running around 4% in Brazil.
Q2 Mobile ARPU (TIMB Investor Relations)
TIM also outperformed Telefonica, their largest competitor, unlike in Q1. Telefonica's revenue only grew 1%, while OIBDA margin was flat. Since the Brazilian telecom market is expected to grow 6% from 2023 to 2028, TIM grew faster than the industry, while Telefonica grew slower.
Setting Up For Growth
Digging further into the results, I feel TIM has set itself up for growth in the back of half 2023 and into 2024. Their stated goals are all focused on growth in high profitability areas.
2H23 Goals (TIMB Investor Relations)
We can't just take management's word for it; we see it in the numbers. In a subscription business, you carry gains and losses forward into the following quarters, and TIM made a lot of gains.
On the mobile side, TIM has significantly decreased churn (while raising prices), has lowered bad debt, and raised NPS score. This shows they are keeping customers happy while increasing the customer base's quality. With a quality customer base, it is hard to swing significantly from quarter to quarter. As discussed above, they are also moving customers into postpaid plans and out of prepaid plans, driving margin.
On the fiber broadband side, TIM set record net-adds while also driving pricing power. And in the earnings call, management stated they believe there is additional pricing power moving forward.
Across the board, TIM is delivering on growth and customer retention, which in my opinion, all but guarantees sustained growth into the next two quarters.
Shareholder Returns Likely To Increase
During the Q2 earnings call , an analyst questioned whether the dividend would increase, given that TIM is generating cash flow at an accelerating rate. Management's response was that cash flow is performing well ahead of expectations, but they need to see what happens with VAT reform first.
The assumed tax rate in Brazil is 34% based on overlapping rates, while the proposed VAT is between 25 and 27%. TIM currently pays an effective tax rate of around 25%, excluding adjusting items. While I appreciate management's caution, I don't believe this is a huge risk for investors.
Cash grew 46% year-over-year, and debt ratios improved materially.
Q2 Cash And Debt (TIMB Investor Relations)
Free Cash Flow also improved by over $1 billion on the backs of higher EBITDA and lower adjusting items.
Q2 FCF (TIMB Investor Relations)
As the balance sheet improves and the company continues to grow, I expect shareholder returns to follow. Especially given that cash flow is exceeding even management's expectations.
Valuation Signals Improving
My prior analysis noted that revenue multiples were elevated while profitability multiples were low. While still elevated, revenue multiples have started closing in on the mean, and profitability multiples are significantly below sector averages. Cash flow, especially, is flashing a buy signal.
TIMB Multiples (Seeking Alpha)
Wall Street analysts are feeling good about the stock, with an average price target of $17, a 15% upside from today's pricing.
The quant rating is also signaling a buy, nearing a strong buy. The only item pulling down the quant rating is growth. Growth is pulled down by EPS, Dividend, and CapEx, all of which have been impacted by the Oi transaction. I expect this to rise as the prior year comparables normalize.
TIMB Quant Rating (Seeking Alpha)
Running a conservative DCF, I get a price target of $21, a 37% upside from today's pricing. I assumed that TIM keeps up with the Brazilian market, maintains a consistent level of CapEx, and has no material cash shocks.
Downside Potential
The first point of downside risk for TIM involves the potential for not maintaining a growth rate at least parallel to the industry level of 6% discussed above. TIM is making aggressive moves that are working for now, but they must avoid alienating customers.
To the point about alienating customers, the second downside risk is the ARPU strategy that benefits rate, unexpectedly impacting volume. In Q2, postpaid volume was only up 2%, taking 0.1% market share, while prepaid was down 3%, losing 0.3 percentage points in market share. While a move from prepaid to postpaid is a winning strategy, TIM needs to watch out for the overall customer base as they raise prices.
The last downside risk is that revenue multiples remain elevated relative to the industry. However, I believe they are outweighed by the profitability and cash flow multiples, as the bottom line is what generates returns at the end of the day.
Verdict
TIM's solid Q2 performance and the promising outlook for Brazil's telecom market make it an attractive investment. The substantial growth in cash flow, combined with an improving balance sheet, indicates growing shareholder returns. Furthermore, my DCF at $21, Wall Street's buy recommendation at $17, coupled with a quant buy rating, and improving multiples, support a bull case for TIM.
Although there continue to be downside risks, such as not maintaining the industry growth rate or volume declines due to rate increases, the overall case for TIM remains strong. As such, I believe it's a good time for investors to enter or expand their positions.
For further details see:
TIM S.A. Had A Better Q2 Than Expected