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Morningstar | Korean Shows Pleasing Recovery in 1Q; FVE to USD 16 but Remains Good Value. See Updated Analyst Note from 07 May 2019

KT’s first-quarter 2019 result was slightly better than expected with both revenue and operating profit showing mild growth compared with declines in fourth quarter last year. Reported service revenue was up 1.9% in the first quarter but down 0.6% in the fourth quarter last year with operating income up 1.3% for the first quarter compared with a 36% decline in fourth quarter last year.

We retain most of our existing forecast assumptions but our fair value estimate falls to USD 16.00 per ADR from USD 17.00 previously due to a weaker Korean won and higher capital expenditure forecasts following higher capital expenditure guidance for this year. 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/fair value of under 0.8 times and we think it’s slightly undervalued. At our fair value, KT would trade on a price/earnings ratio of 11.9 times and a dividend yield of 2.9%. Management provided its first capital expenditure guidance for 2019 at this result, guiding to KRW 3.3 trillion up from KRW 2.3 trillion in 2018 given increased spending on 5G network rollout and increased disaster safety preparedness. This new forecast is 10% higher than our previous forecast of KRW 3.0 trillion. 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 grew by 0.2% after declining by 2.3% for 2018 and 6.2% for fourth quarter 2018, as the impact of the government mandated discount for customers not taking a handset subsidy began to wane. At the full year result in January, KT indicated that it expected growth to return to the wireless services market only in the second half of 2019, so the recovery has been faster than expected. KT added 56,000 handset customers and 169,000 customers in total.

Having launched 5G service in April, KT claimed 100,000 5G customers within the first month, but we do have some concern about KT offering unlimited data plans with 5G services given the potential for it driving increased network expenditure. The company targets around 10% of its customer base to be on 5G by the end of the year which should equate to around 2.2 million customers. 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 have gained ground again in 2018 and early 2019, albeit in a stagnant market.

KT’s wireline revenue declined 2.7% year on year. Telephony revenue declined 8.6% with broadband revenue declining 0.1% and line lease revenue increasing 2.5%. The company adding 53,000 broadband customers and 170 fibre-to-the-home services called “GIGA”, now representing 57.6% of its broadband subscriber base. The company also added a further 115,000 IPTV customers this quarter bringing its total to 8 million customers and driving 15.7% 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 two to three 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.