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Morningstar | Slightly Below-Par 3Q for KDDI; Potential Price Cuts, Rakuten Entry Overhang; FVE Still JPY 3,400

KDDI’s fiscal 2018 third-quarter result (quarter ended December 2018) was slightly below our estimates, with revenue decreasing 2.6% and operating income decreasing 3.7%. However, management’s fiscal 2018 guidance for operating income growth of 5.9% and dividend growth of 11% to JPY 100 per share remains. The big Japanese telecom issues of NTT DoCoMo’s upcoming price cuts and Rakuten’s entry remain to play out. Three months ago, NTT DoCoMo foreshadowed price decreases that will return as much as JPY 400 billion to customers and see operating profit decline with a target of recovering operating profit to current levels by fiscal 2023. KDDI indicated that it believes it has already implemented much of what NTT DoCoMo plans to implement with its Pitatto and Flat Plans introduced in mid-2017; however, management will wait to see what plans NTT DoCoMo implements in April before deciding on a response.

We believe KDDI will likely have to tweak its prices down in certain areas to match NTT DoCoMo, and we reduced our fair value estimate to JPY 3,400 and USD 15 per ADR after the initial announcement at the second-quarter result in November 2018.  We make only slight increases to our depreciation forecasts after this result but no changes to our fair value estimate. At this fair value estimate, KDDI would trade on a price/earnings ratio of 13.6 times with a 2.9% 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 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 four years are broadly flat. We retain our narrow moat rating based on cost advantage and efficient scale and our negative moat trend rating based on Rakuten and the expected upcoming pricing pressure.

KDDI is trading below our fair value estimate, making it an attractive stock, especially with Japanese 10-year government bonds close to zero.

KDDI’s telecom operating income decreased 3.6%, with value-added services up 10.4% partially offset by business (down 1.9%) and global services (down 3.9%). Mobile network revenue was up only 0.4% due to the impact of the new price plans; however, total mobile revenue including MVNO revenue was up 2.0%. In November 2018, KDDI announced a strategic cooperation with Rakuten whereby KDDI will provide Rakuten with roaming in areas where Rakuten does not have network and Rakuten will share its payments and logistics infrastructure. While we would prefer that none of the existing operators provide roaming for Rakuten, to increase the likelihood that Rakuten’s foray into mobile networks would fail, if it is going to happen it is best to be the operator that provides the services. This will allow KDDI to generate revenue from Rakuten’s customers and accelerate its efforts in electronic payments and logistics.