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Morningstar | NTT’s Full-Year Slightly Below Expectations but Positive Board Changes Planned; FVE Cut to JPY 5,200. See Updated Analyst Note from 13 May 2019

On an underlying basis, narrow-moat Nippon Telegraph & Telephone Corp's, or NTT’s, fiscal 2018 (year ending March 2019) result was slightly below our expectations as was the company’s guidance for fiscal 2019. We make slight downgrades to our earnings forecasts and reduce our fair value estimate to JPY 5,200 per share from JPY 5,400 previously. Our fair value estimate implies a forward price/earnings multiple of 11.6 times and a 3.7% dividend yield with the stock looking slightly undervalued at this price but we would wait for a lower price to buy. Yearly revenue increased by 0.8% with operating profit up 3.2%. Excluding the JPY 120 billion one-off settlement payment from Tata in the previous year, net profit would have risen by 4.8%. 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 seems to be putting a bigger focus on its dividend, and provided guidance for fiscal 2019 of an increase in the dividend to JPY 190 per share from JPY 180 in fiscal 2018. This has risen drastically from JPY 120 in fiscal 2016. This will see the dividend payout ratio increase to 41.7% from the low 30 percent range over the past three years. With a net debt/EBITDA ratio of only around 1, we believe the company could afford to continue to gradually increase the dividend payout ratio so that it could continue to increase the dividend.

Indeed, management indicated at this result that it is targeting continual dividend increases and has no fixed dividend payout ratio in mind. In addition to the dividend, the company plans to buyback around JPY 250 billion worth of stock over this fiscal year, having averaged JPY 289 billion per year over the past three years.

NTT is targeting new revenue sources to help replace some of the declining core telecom revenue. B2B2X, which stands for business-to-business-to-business/customer, is a new business model where a telecom service provider integrates telecom and IT services capabilities with applications used by enterprises to offer services to customers, retailers, partners, suppliers or any other entities that might make up the “X”. NTT has set a B2B2X sales target of JPY 600 billion by fiscal 2023. It has also set a target of JPY 600 billion of sales by fiscal 2025 for smart energy business and purchased 51% of Ennet, a local power generator and retailer, who is looking to increase its power source procurement capabilities and expand its power retailing channels. It is also establishing a new company called NTT Life Science to leverage NTT Group’s data analysis and security technology to establish a health care recommendation business. It will use big data to analyze genome, health and behavioral data to provide health care information through data analysis.

Encouragingly, NTT is putting a proposal forward for the Annual General Meeting scheduled for June 25 to increase the number of independent directors on its board to four out of a total of 15 from the current two out of a total of 12. It also plans to add two female directors to its currently all-male board.

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. Around 12.7 million of its 21 million total fibre broadband connections are now via wholesale with 327,000 wholesale broadband customers added over the quarter and 1.6 million added over the year. The full-year target is to reach 13.9 million of 21.7 million fibres lines as wholesale so the rate of wholesale customer adds is expected to decline. 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.