EUR 850.00 For Business Accounts Only

Morningstar | China Telecom Pushes for Increased Scale in 2018 and 2019 to Boost Profitability Later

China Telecom’s 2018 result was solid with services revenue up 5.9%, EBITDA up 2.0% and net profit up 13.9%. The service revenue growth was in line with China Unicom’s full-year number and both are likely significantly better than China Mobile, which reported 0.6% growth for the first three quarters of the year. All three operators battled the removal of mobile data roaming charges in the second half of the year which lowered mobile services revenue growth. If no further Government-led price reductions are mandated in the second half of 2019, we should see a return to mid-single-digit industry services revenue growth. China Telecom has taken the opportunity in 2019 to increase its scale adding 53 million mobile customers (45% of industry net adds) and 12 million broadband customers, both much higher than recent years. The associated subscriber acquisition costs have weighed on profitability this year but should set the company up better for future revenue and profit. However, management indicated that it would continue to push for increased scale in 2019 so we expect the profitability benefits may be delayed until 2020 and beyond.

We retain our fair value estimate for China Telecom HKD 4.80 (USD 62.50 per ADR) representing only 15.9 times 2019 forecast earnings per share and still above the stock price despite recent stock price increases. 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.

The key driver of China Telecom’s result was growth in mobile data revenue of 19.5%. Mobile handset data traffic volume grew at over 290% for 2018 after growing at 180% in 2017. Newer fixed line services also provided growth through Internet data centres which grew revenue 22% to CNY 23.4 billion and cloud services revenue which grew 86% to CNY 4.5 billion. Internet of Things, which will gain a big boost from the move to 5G technology, is also showing signs of strong growth from a low base. Internet of Things revenue grew 125% to CNY 1.5 billion with the number of connected devices growing 141% to 106.9 million. China Telecom continued to take revenue share in mobile, growing mobile services revenue at 9.1% compared with China Unicom at 5.5%. Although a full cash flow statement was not provided, operating cash flow was up 2.9%. Like China Unicom, China Telecom has set aside relatively modest capital expenditure for 5G in 2019. China Telecom expects 5G capital expenditures of CNY 9 billion compared with the CNY 5 billion to 8 billion for China Unicom. China Telecom is expecting total capital expenditure to increase by 4% to CNY 78 billion with expenditure on the non-5G businesses set to fall 8%. China Telecom currently has 5G trials in 17 cities with around 2,000 base stations and will chose 3 to 4 cities for more extensive network coverage and trials in 2019. By the end of 2019 it expects to have 20,000 base stations.

The Chinese government recently announced plans to reduce mobile data prices by 30% in 2019. We note that China Telecom has easily met this criterion over the past few years with mobile data prices down 38% in 2016, 53% in 2017 and 69% in 2018. We would expect competition and continued move of customers to more efficient 4G networks would see prices naturally fall by more than 30% so we do not see this Government plan as a significant negative for the telecom operators. As Chinese consumers conduct more of their daily life on their smartphones, the role of the telecom companies becomes crucial for a competitive economy. The Government wants the telecom companies to continue to invest and to provide faster services at lower prices so we would not expect the Government to force unduly harsh price cuts so it can encourage sufficient investment from the operators.