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Morningstar | Cost-Cutting Drives Strong 3Q from NTT with Dividend Guidance Raised for This Year. See Updated Analyst Note from 07 Feb 2019

On an underlying basis, narrow-moat Nippon Telegraph and Telephone Corp's, or NTT’s, third-quarter fiscal 2018 (quarter-ending September 2018) result was slightly better than our expectations and the company lifted its full-year dividend guidance to JPY 180 per share from JPY 170 per share.

We keep our earnings forecasts largely unchanged and retain our fair value estimate of JPY 5,400. Our fair value estimate implies a forward price/earnings multiple of 11.7 times and a 3.3% dividend yield with the stock looking undervalued at this price. First-quarter revenue declined by 2% but EBITDA before impairments and asset sales rose 7% as the company continued its focus on cost-cutting. We continue to rate NTT as a narrow-moat company, despite its return on invested capital, or ROIC, having historically been below its weighted average cost of capital, or WACC. Given the improved earnings both organically and from 67%-owned NTT DoCoMo, we note NTT’s ROIC rose above WACC in fiscal 2016 and we forecast it to remain there throughout our forecast period. As an incumbent telecom operator, NTT benefits from an efficient scale moat source with much of its fixed-line network highly unlikely to be overbuilt and a low likelihood of successful new entry into the three-player mobile market on a long-term basis, despite Rakuten planning to enter the market in 2019.

NTT DoCoMo, which contributes around two thirds of NTT’s profits, is targeting to only return operating profits to fiscal 2017 levels by fiscal 2023 but NTT management indicated that it would be working with NTT DoCoMo to attempt to reduce costs further with a target of no reduction in NTT DoCoMo’s operating profit. We forecast NTT’s EPS to grow to JPY 516 by fiscal 2022, which is the outer year of our specific forecasts so we are below NTT management’s own forecast as per its medium-term plan to grow its EPS from to JPY 640 by fiscal 2023 from JPY 425 underlying in fiscal 2017.

We continue to get mixed messages from the management teams of NTT DoCoMo and NTT management and we are siding with NTT DoCoMo (which is directly in control) for the time being.

NTT seems to be putting a bigger focus on its dividend. Its new guidance would see the dividend grow from JPY 120 two years ago to JPY 150 last year and JPY 180 this year. On our estimates, this will see the dividend payout ratio increase to the high 30 percent range from the low 30 percent range over the past three years. With a Net Debt to EBITDA ratio of only around one we believe the company could afford to continue to gradually increase the dividend payout ratio so that it could continue to increase the dividend even if earnings growth slows.

NTT continues to benefit from the move to the Hikari Collaboration Model whereby resellers take over the sales and marketing expense for wholesaled broadband lines. 12.4 million of its 21 million total fibre broadband connections are now via wholesale with 370,000 wholesale broadband customers added over the quarter. At this rate, NTT’s Hikari Collaboration cost savings will likely diminish in around two years, after which we forecast flatter margins. The company now has over 700 broadband resellers including companies in telecoms, energy, real estate and security, although 90% of its wholesale customers connect via NTT DoCoMo and SoftBank.