EUR 850.00 For Business Accounts Only

Morningstar | Solid Result, but Potential Price Cuts and Rakuten Entry Are Overhangs; FVE to JPY 3,400. See Updated Analyst Note from 01 Nov 2018

KDDI’s second-quarter fiscal 2018 result (quarter ending September 2019) was broadly in line with our estimates, with revenue increasing by 1.9% and operating income increasing by 4.3%. Managements’ fiscal 2018 guidance for operating income growth of 5.9% and dividend growth of 11% to JPY 100 per share remains unchanged. However, its key competitor, NTT DoCoMo, foreshadowed price decreases on Oct. 31 that will return up to JPY 400 billion to customers and see operating profit decline with a target of recovering operating profit to current levels by fiscal 2023. KDDI’s stock price fell 16% on this news. 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 and that it will have already returned around JPY 300 billion to customers by the end of this fiscal year. If this is true, then KDDI would not see the expected profit decline that NTT DoCoMo is projecting. Management’s new medium-term plan to be released at the end of this fiscal year will be much awaited, but management hinted that it would be striving for continued profit growth.

We believe KDDI will likely have to tweak its prices down in certain areas to match NTT DoCoMo. We reduce our fair value estimate to JPY 3,400 and USD 15 per ADR from JPY 3,700 per share and USD 17 per ADR as we assume KDDI at least partially responds to NTT DoCoMo’s proposed pricing, reducing our EBITDA forecasts by around 8% over the next three years. Note, our fair value estimate reduction is around half of the share price movement today. At our new fair value, KDDI would trade on a price/earnings ratio of 13.4 times with a 3.0% dividend yield. We retain our narrow moat rating based on cost advantage and efficient scale. KDDI’s shares are trading below our fair value estimate, making it an attractive stock, especially with Japanese 10-year government bonds yielding around 0.1%.

KDDI’s telecom operating income increased by 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 fell 0.9% due to the impact of the new price plans, but total mobile revenue, including MVNO revenue, was up 1.5%. 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 will allow it to accelerate its efforts in electronic payments and logistics.