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Morningstar | China Mobile Reports Solid 1H Result; FVE Reduced to HKD 100 on Weaker Currency; Still Good Value. See Updated Analyst Note from 09 Aug 2018

China Mobile's first-half 2018 result was slightly ahead of our expectation, with underlying service revenue up 5.5%, EBITDA up 3.7%, and net profit up 4.7%. We retain our narrow moat rating on the stock but reduce our fair value estimate to HKD 100 (USD 64 per ADR) from HKD 102 per share (USD 65 per ADR) on the back of a much weaker Chinese yuan partially offset by slight earnings upgrades and the inclusion of its equity stake in China Tower. This fair value implies a forward P/E of 15.6 times and a dividend yield of 3.0% making China Mobile shares attractive at current levels in our view. We expect the company to be able to maintain its earnings growth at mid-single-digit rates per year in the medium term. We also retain our Poor stewardship rating on China Mobile based primarily on the company's poor capital management track record.

Over 2015 and 2016, China Unicom was not very competitive in the mobile market, allowing the other two Chinese operators to take market share, but the mobile market became more competitive in 2017 and this has continued in the first half of 2018. With China Mobile generating around 85% of its revenue from mobile, this development is significant for the company. In addition, nationwide mobile data tariffs were introduced from July 1, 2018, with the company admitting this was likely to be an unquantified negative for revenue in the short term. However, this development also represents an opportunity to further reduce complexity and costs in marketing and customer service in the medium term. Handset data traffic continued to accelerate, as we have seen in most telecom markets across the region. The 121% data traffic growth in 2017 became 139% in first-quarter 2018 and 164% in second-quarter 2018.

While this growth is not translating to overall ARPU growth given data price reductions, falling voice revenue, and the increase in multi-SIM users, we see it as a very positive sign for the long-term future of the telcos as people (and devices) are becoming more and more dependent on telecom networks to provide the data connections required to function efficiently.

To offset increasing competition in mobiles, China Mobile is boosting its growth through other peripheral products and services such as fixed-line broadband, the Internet of Things, and value-added products. It is using its fixed-line capabilities to attack both the household and business markets growing broadband service revenues by 45%, its Internet Data Centre business by 56% and its dedicated business lines revenues by 27%. It also added 233 million Internet of Things connections to its network over the past six months to bring its total to 384 million at the end of June. While these connections are only generating ARPU of RMB 2 per month, the growth is very strong and there are potentially many more Internet of Things connections to be made than there are human customers. Even its existing Internet of Things base generating RMB 2 per month would add over 1% to its existing services revenue base and with current connection growth rates this could end up being a significant source of growth for the telcos. China Mobile indicated that connections were being made in the areas of monitoring, family and household security, and mobility products in vehicles.

China Mobile committed itself to a first mover advantage in 5G. It claimed that it had over 500 patents on parts of the 5G standard and already had 5G trials in 17 cities (five for network and 12 for applications). The target is still commercial rollout in 2020. It also confirmed that its existing network equipment is capable of functioning in FDD mode as well as the existing TDD. It prefers FDD in rural areas because of its better coverage while it prefers TDD in densely populated cities given it has more available spectrum for that technology in those locations. It is still too early for the operators to provide details on 5G capital expenditures but we have assumed that China Mobile's overall capital expenditures increases from RMB 166 billion this year to over RMB 200 billion in each of 2020, 2021 and 2022, or over 23% of sales, before falling back to 19% of sales in the outer years of our forecasts.