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Morningstar | China Telecom Continues to Take Mobile Share in 1Q; FVE Increased to HKD 4.90

China Telecom’s first-quarter 2019 result was the standout of the Chinese telecom sector with service sector growth of 4.1%, EBITDA growth of 14.1%, and net income growth of 4.5% compared with industry growth of 0.9%, 6.5% and negative 3.4% respectively. All three operators battled the removal of mobile data roaming charges from July 1, 2018 which lowered mobile services revenue growth. They also implemented a new accounting standard, IFRS16, and did not adjust previous period numbers for this standard. Broadly, the new standard had the effect of decreasing operations and maintenance expenses and increasing depreciation and interest expenses. For this reason, we believe bottom line profit growth gives a better read on the industry this year than EBITDA growth, but we also note that China Telecom disclosed that its net profit growth would have been around 250 basis points higher without the accounting standards change. If no further Government-led price reductions are mandated in the second half of 2019, we believe that we should see a return to mid-single-digit industry services revenue growth, with profits growing at a faster pace given operational leverage. China Telecom has continued with its strategy from last year of increasing its scale, particularly in its mobile business, adding 12 million mobile customers (46% of industry net adds) in the first quarter. The associated subscriber acquisition costs have weighed on profitability but should set the company up better for future revenue and profit.

We increase our fair value estimate for China Telecom to HKD 4.90 (USD 63 per ADR) from HKD 4.80 (USD 62.50 per ADR) previously on the back of a slightly stronger local currency. The new fair value represents only 15.9 times 2019 forecast earnings per share and the stock is now in 4-star territory given a slight stock price decline since the full-year result announcement about five weeks ago.

We make no changes to our no-moat rating for China Telecom which stems from its returns remaining below WACC. Its returns have remained below WACC for each of the past 10 years and we expect this to remain the case in our forecast period despite our expectation that returns will improve.