EUR 850.00 For Business Accounts Only

Morningstar | Cancellation of Domestic Data Roaming Fees Jolts China Unicom’s Growth in the 3Q

China Unicom’s third-quarter result was negatively impacted by the cancellation of domestic data roaming fees from July 1 with services revenue growth slowing from 8.3% in first-half 2018 to 2.9% in the third quarter. EBITDA also slowed from 5.2% growth in the first half to 5.1% decline in the third quarter due to the revenue slowdown and a 13% increase in employee expenses associated with the mixed ownership reforms which allow for increased performance-based pay for staff.

We maintain our fair value estimate at HKD 11.40 and USD 14.50. China Unicom remains narrow-moat-rated based on cost advantages with a negative moat trend due to the company’s declining technology advantage as the market moves away from 3G mobile. At these price levels, the company is undervalued and in 4-star territory.

With the mixed ownership reform implemented in the second half of 2017, China Unicom’s employee incentive share scheme includes seemingly high growth targets over the next three years. The three-year target for service revenue growth is 6.5% per year to CNY 301.1 billion by 2020. The pretax profit target is for 68.7% per year growth to CNY 25.4 billion by 2020. The cancellation of domestic roaming fees will make these targets difficult to achieve in our view as they will lead to a year with minimal growth. We forecast services revenue of CNY 287 billion and pretax profit of CNY 22.5 billion by 2020. Indeed, the seemingly random industry price reductions stipulated by the regulator are having a negative impact on operators’ profits and making it harder for the smaller operators to return to earning positive real economic returns. With China Unicom foreshadowing target 5G commercial launch in 2020, we would expect its returns to remain constrained until the heavy 5G investment period ends in 2022.

Beyond that, we expect returns to improve drastically as underlying demand for mobile data services remains very strong and China remains committed to a high tech future which will rely on telecom services.

Despite our view that the three-year incentive targets will be a stretch, mobile customer trends continue to be positive for the company with China Unicom adding 2.6 million mobile customers in September and 25.7 million year-to-date giving it around 26% share of new customer adds this year-to-date, up from 22% in 2017 and 9% over the three years from 2014 to 2016. China Unicom has been slowly gaining mobile market share since mid-2017 with its market share improving to 20.3% from a low of 19.7% over that period. This bodes well for its near-term revenue growth rates relative to the other two operators, although each of the Chinese operators will be negatively impacted by the cancellation of domestic data roaming fees.