EUR 850.00 For Business Accounts Only

Morningstar | In Line Result; Upcoming Rakuten Entry is an Overhang; FVE Retained at JPY 3,400

KDDI’s fourth-quarter fiscal 2018 result (quarter-ending March 2019) was within our estimates and guidance for both this year and the medium term was solid in the face of potential increasing competition. Revenue increased by 2.6% with operating income up 28% and the company added JPY 5 to the previously guided dividend announcing a total of JPY 105 per share for fiscal 2018 and targeting JPY 110 for fiscal 2019. KDDI is guiding for 2.4% revenue growth, 0.6% operating income growth and 0.4% net profit growth this year. Over the next six years it is targeting an average of 7% per year earnings per share growth, which probably implies around 5% per year earnings growth post annual share buybacks.

The guidance provided by both SoftBank and KDDI of mild earnings growth this year implies that neither company expects to have to make significant price cuts in response to NTT DoCoMo’s announced price cuts and guidance for earnings decline this year. This gives us some confidence in the competitive environment ahead of Rakuten’s entry into the market.

We retain our fair value estimate for KDDI of JPY 3,400 and USD 14 per ADR. At this fair value, KDDI would trade on a price/earnings ratio of 12.9  times with a 3.2% dividend yield. We believe the Japanese telecom market is a solid three-player market with manageable competition levels but this looks likely be challenged by both Rakuten’s planned entry as a network operator in 2019 and the Government’s influence over operator pricing.  Our operating profit forecasts over the next five years are broadly flat. We retain our narrow moat rating based on cost advantage and efficient scale and our negative moat trend based on Rakuten and the expected upcoming pricing pressure. KDDI’s shares are trading below our fair value estimate making it an attractive stock, especially with Japanese 10-year Government bonds close to zero.

On each company’s own fiscal 2019 guidance KDDi trades on a price/earnings ratio of 10.3 times compared with SoftBank Corp and NTT DoCoMo which trade on around 14 times.

KDDI provided some detail in its medium-term plan. It is targeting 93.2% 5G area coverage within five years implying 42,863 outdoor base stations. Revenue expansion over the next three years is expected to be driven by growth in the Life Design area from JPY 946 billion in revenue in fiscal 2018 to JPY 1.5 trillion in fiscal 2021. The company is also targeting growth in Internet of Things connections from 8 million currently to 18 million by March 2022. Given the uncertain future competitive environment KDDI is also targeting JPY 100 billion in cost reductions through network virtualization, automation and revising operation methods. Earnings per share in fiscal 2024 is targeted at 50% greater than fiscal 2018, implying an average of 7% per year growth over the next six years. The fact that management is only guiding to 1.8% EPS growth in fiscal 2019 and Rakuten has yet to start up as the fourth operator shows that this won’t be that easy despite the company reporting historical six-year annual EPS growth of 12%. The company announced a buyback of up to JPY 150 billion to run from May 16, 2019 to Dec. 23 2019.