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Morningstar | China Mobile Reports Weak Full-Year Result, Particularly Cash Flow; FVE Reduced to HKD 97

China Mobile’s 2018 result was below our expectation with underlying service revenue down 3.7%. While the company reported EBITDA up 1.9% and net profit up 3.1%, we note that operating cash flow was down around 16%, the second year in a row that operating cash flow has declined despite reported earnings growth. We retain our narrow moat rating on the stock but reduce our fair value estimate to HKD 97 (USD 61) from HKD 105 per share (USD 66 per ADR) on reduced earnings forecasts despite a slight strengthening of the CNY. This fair value implies a forward P/E of 14.6 times and a dividend yield of 3.3% making China Mobile shares mildly attractive at current levels in our view. We expect the company to be able to maintain its earnings growth at low-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.

We had noticed that operating cash flow looked like it fell around 14% in the first-half 2018 result and were hoping for a turnaround in the second half. Unfortunately, it looks like this did not happen. While a full cash flow statement is not provided with the full year announcement, China Mobile indicated that free cash flow fell from CNY 68 billion in 2017 to CNY 39 billion in 2018. Given capital expenditure fell from CNY 177.5 billion to CNY 167.1 billion it looks like operating cash flow has fallen by around CNY 39 billion (or around 16%) for 2018. This follows operating cash flow falling by 3% in 2017. Indeed, 2018’s operating cash flow is the lowest reported by the company since 2008. China Mobile indicated that this was partly due to the increased focus on the business and corporate market who get better payment terms than consumers and we note that accounts payable reduced by CNY 42 billion.

But generating cash flow has been the hallmark of China Mobile and this year is the first year that China Mobile has ended up with a significantly lower net cash level than the previous year. The most concerning thing about this is that 2018 is arguably towards the “harvesting” end of the 4G cycle when capital expenditure is lower, ahead of the 5G capital expenditure upcycle. China Mobile should be “making hay” but competition from the other operators is causing it cash flow problems.

The level of competition from the other operators can be gleaned from a quick glance at 2018 results of each of the operators. Both China Unicom and China Telecom reported services revenue growth of 5.9% while China Mobile reported service revenue growth of only 0.4% (corresponding to an underlying decline of 3.7% on like-for-like accounting standards for China Mobile). Each of China Mobile’s competitors also reported growth in free cash flow with China Unicom’s free cash flow of CNY 47 billion outstripping China Mobile’s CNY 39 billion in absolute terms for the first time. As previously noted, competition in the mobile market, which represents around two thirds of the total telecom market in China, is really heating up. In 2018 China Telecom added 44% of net new customer adds in the market with China Mobile adding 31% and China Unicom adding 25%. In the first two months of this year China Telecom has added 47% of net new customer adds in the market with China Unicom adding 31% and China Mobile only adding 23%. Industry mobile service revenue as reported by the operators has been flat year-on-year, but China Telecom reported 5.9% growth, China Unicom reported 5.5% growth and China Mobile reported 3.9% decline.

China Mobile was less forthcoming on 5G details than the other operators but it appears that industry 5G capital expenditure in 2019 will be quite contained. China Mobile did not provide a specific 5G capital expenditure estimate for 2019 while China Telecom expects 5G capital expenditure of CNY 9 billion compared with CNY 5 billion to 8 billion for China Unicom. China Mobile indicated that its total capital expenditure would be lower than 2018 which implies a maximum 5G capital expenditure of CNY 17 billion and it also planned 30,000 to 50,000 5G base stations on 2019. All operators admit that 5G products, business models and even charging models are still being explored and it is likely that 5G will be far more complex than 4G where operators are pretty much charging for bulk mobile data directly to consumers. 5G will see operators partnering with service/app providers and offering services to business as well as consumers. The uncertainty makes 5G difficult to forecast and model.