Down 30%, are Airtel Africa shares now undervalued?

Last year was not a guarantee for shareholders in telecommunications operators Airtel Africa (LSE: AAF). In that time, Airtel Africa shares have lost 30% of their value. They now trade for no more than a pound each.

That puts the company at a price-to-earnings ratio of 8, which seems cheap to me.

Last year’s revenue increased by 21%, while profit after tax increased by 82%. That’s a big number.

So why are these stocks down – and do their current prices make them attractive as potential additions to my portfolio?

A growing business

The company’s business continues to grow strongly. Revenue in the first nine months of the current financial year is up 12% year-on-year. Profit after tax increased by 2%. Operating free cash flow increased 15%.

Airtel Africa seems to be moving forward. Set against that, faster profit growth than post-tax profit can be a sign of declining profit margins. This is a risk because the company seeks to continue to grow, although with a net profit margin in the first nine months of 13%, the company’s income remains quite large.

I believe that these companies are well positioned to benefit from the adoption of digital payments in Africa. In the most recent quarter, the value of mobile money transactions grew by 37% to an annual rate of close to $100bn.

Possible risks

But why is a profitable company in growth mode focused on a market with a huge untapped opportunity seeing its stock drop 30%?

I think part of the reason is the risk environment. Africa is a volatile market with a lot of political risk. The recent uproar in Nigeria over a switch in the legality of banknotes is an example of how operators in these places can face extensive and sometimes unpredictable risks. Then again, that particular instance could provide an opportunity for mobile money arm Airtel, which has large operations in Nigeria.

Net debt also rose in the most recent quarter, reaching $3.6bn. For a company with a market capitalization of £4bn, that is getting high. Serving can eat dividends.

Are stocks cheap?

Despite these risks, I think the share price of the telecommunications company is looking low right now.

The addressable market is large and numerous. Penetration remains lower than in some other markets. Mobile money growth could be a profit driver for Airtel Africa in the coming years on top of already growing revenue.

Although there are risks, I Share has been priced to reflect them.

I am wary of investing in businesses that are heavily exposed to only a few African markets, as the risks can be substantial. So, even though I think this stock is undervalued, I have no plans to buy it in my portfolio right now. I will keep an eye on the company though, and may decide to put my toes in the water if I become comfortable with the political risks involved.