EUR 850.00 For Business Accounts Only

Morningstar | Solid Third-Quarter Results for KT Again, and It Remains a Good Value

KT’s third-quarter results were broadly in line with our forecasts on an underlying basis despite the large reported operating profit decline. Services revenue was up 1.8% after reporting a 0.5% decline in the first half and operating income down 15% on a reported basis using the old accounting standard. Early resolution of a labor collective bargaining agreement in second-quarter 2018 caused a one-off spike in labor costs in both the second and third quarters of this year that was the main driver of the operating profit decline. Excluding this, we estimate that operating profit would have been broadly flat. We make small adjustments to our forecasts but retain our fair value estimate at USD 18.00 per ADR and continue to base our earnings forecasts on the old accounting standard until the company provides 2017 numbers with the new standard. Our forecasts incorporate operating earnings declining by around 3% per year over the next five years, which we think is conservative but despite this the stock trades at a price to fair value of under 0.8 times and we think it’s undervalued. At our fair value estimate, KT would trade on a price/earnings ratio of 12.1 times and a dividend yield of 3.2%. We also retain our narrow moat rating based on efficient scale with the incumbent mobile operators having many advantages over any credible potential new entrants considering joining the market.

Mobile services revenue declined by 2.5%, not helped by the government-mandated discount for customers not taking a handset subsidy. While revenue declines are not ideal, KT performed better than larger rival, SK Telecom, which reported 8.5% mobile service revenue decline in this quarter. This is largely due to its continued addition of customers with KT adding and average of 100,000 mobile customers per month this year to date compared with SKT’s 18,000 per month.

In September 2017, the Korean Ministry of Science and ICT increased the discount rate provided to customers not taking a handset and associated handset subsidy from 20% to 25%. This has been applied to re-contracting or new customers since 15 Sept. 2017. Existing subscribers that opted for the 20% rate discount plan are also allowed to apply for a 25% discount if there is less than six months remaining on their contract. At the full-year 2017 result in February, management indicated that around 59% of new and upgrading customers are opting for a selective tariff discount plan and the cumulative rate was around 32%. After KT outperformed key rival SKT in the mobile market over 2015 and 2016, we saw SKT get a bit more aggressive in 2017 but KT seems to be gaining ground again in 2018. We believe the underlying traditional customer base is likely to be broadly flat for both operators with much of the growth coming from second device, Internet of Things, and business-to-business users.

KT’s wireline revenue declined 1.9% year on year, also broadly in line with 2017’s full-year decline. Telephony revenue decline of 6.1% was partially offset by broadband revenue growth of 1.6% with the company adding 263,000 fibre-to-the-home services called “GIGA,” representing 54.2% of its broadband subscriber base, despite the overall broadband customer base declining. After averaging net adds of 21,000 per month over the 12 months to January 2018, total broadband customers actually declined by 59,000 in February and 69,000 in March. The company returned to a decent growth rate this quarter adding 39,000 customers. The company also added a further 103,000 IPTV customers this quarter, bringing its total to 7.8 million customers and driving 9.2% growth in media/content revenue for the quarter. Although it does not formally provide margin breakdowns, management indicated the IPTV business reached breakeven in 2017 on a full-year basis, and profitability improvement continues. It has previously stated that it expects the business to generate margins in line with its telecom business in 2-3 years. By our estimates, this would add around KRW 150 billion to KRW 200 billion of operating profit over this period or 10% to 14% on top of the current overall operating profit.

We are cognizant that any continued declines in wireline revenue and profit may eat into some of this growth, but if the IPTV profitability does improve as planned this would likely provide some upside to our company forecasts, which have around 3% per year decline in operating income over the next five years. Real Estate revenue also increased by 35% with the confirming its previous announced target to at least KRW 700 billion by 2020, up from KRW 430 billion in 2017. Management has previously estimated that the company’s real estate assets have a current market value of KRW 8.8 trillion, which is nearly 80% of its current enterprise value. We doubt if investors put anywhere near this value on these real estate assets.