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Morningstar | China Unicom's Strong Underlying 1Q Result Foreshadows Solid Full Year

China Unicom’s underlying first-quarter result was positive, with mild revenue growth and strong profit growth despite the government’s mandated removal of data roaming fees in July 2018 driving mobile services revenue into decline. With the effect of the mobile data fee removal set to wash through in the second half of the year, the company appears set to produce strong profit and cash flow growth this year. First-quarter services revenue growth of 0.3% consisted of fixed services revenue up 9.4% and mobile services revenue declining 5.2%. Excluding the impact of the data fee removal, we estimate underlying mobile services revenue growth would likely be midsingle digits. Given some accounting changes reducing operating and support expenses but increasing depreciation, which were not applied to historical numbers, operating income is probably the best measure of profitability, and this was up a very strong 16.1%. Employee benefits, which grew 13% in 2018 driven by the more flexible approach to employee pay afforded with the mixed ownership reform, were brought under control this quarter, declining 2.8%. The sum of depreciation and operating and support expenses declined 6.3% with underlying depreciation expense decreasing 8.6% largely due to capital expenditure reductions, with 2018 capex of CNY 45 billion and 2019 capex forecast at CNY 58 billion.

We forecast full-year revenue growth of 4.7% and operating income growth of 23%, implying some recovery in second-half growth, and we make only minor changes to our forecasts, retaining our HKD 13 (USD 16.60 per ADR) fair value estimate. This fair value implies a forward price/earnings of 29 times and a dividend yield of 1.4%, making China Unicom’s shares attractive at current levels. We expect the company to increase operating earnings at an average of 17% per annum over the next five years as its operating margin recovers from a low 3.1% in 2018 to 5.9% by 2023. China Unicom is a sold 4-star stock at these levels.