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Morningstar | NTT DoCoMo Foreshadows Price and Earnings Cuts; FVE Reduced to JPY 2,500

NTT DoCoMo’s second-quarter 2018 (quarter ending September 2018) result was in line with our expectations and puts the firm in a good position to achieve or beat its own full-year guidance. However, its medium-term plan involving a review of mobile rate plans 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 was a negative shock to us. Our fair value estimate is reduced to JPY 2,500 and USD 22 per ADS from JPY 2,800 and USD 26 per ADS on the back of the medium-term plan. Our narrow moat rating is retained given forecast returns remain above WACC. NTT DoCoMo’s current share price is now above our fair value and we would expect some share price volatility as shareholders digest the new information. We are now forecasting flat JPY 110 per share dividends over the next five years, instead of our previous forecast of a steady rise in dividend.

The concern for us with this medium-term plan is how much influence the government has on NTT DoCoMo’s pricing plans and future returns. Government comments about how much Japanese customers pay for mobile service made in August 2018 seem to have hit the mark. Previous comments from government along the same lines in 2015 and 2016 did provoke a response from the operators, but did not have such a negative impact on profits as expected for these cuts. Management also indicated the entry of Rakuten into the market in 2019 was also an influence over the planned rate cut decision. To the extent they will make it more difficult for Rakuten to attract customers, then this may be a good thing for the industry in the longer term. Given these plans are targeted at reducing pressure from the government, we expect NTT DoCoMo has an incentive to maximize the forecast negative impact on the company, hence the forecast of “up to JPY 400 billion” to be returned to customers. We expect the actual impact will likely be smaller.

In terms of forecast impact, we have no details on the new low-cost plans to be announced and launched in first-quarter fiscal 2019 (quarter ending June 2019) and whether they will automatically apply to existing customers or whether they will apply as customers come off existing contracts. We assume the forecast customer returns will be spread across two years. We also expect NTT DoCoMo to continue with its underlying cost-cutting which has been running at over JPY 100 billion per year so this should be able to absorb some of the impact. However, we also recognize that NTT DoCoMo will be spending on 5G and associated new service development given its plans to have a precommercial 5G service launched from September 2019 in time for the Rugby World Cup with a commercial 5G service launch in Spring 2020. The outcome is our forecast of NTT DoCoMo’s operating profit to fall to the mid JPY 800 billions for three years from fiscal 2019 to fiscal 2021, a reduction of around 19% for fiscal 2020 and 2021, before recovering towards to the JPY 990 billion target by fiscal 2023.

NTT DoCoMo’s second-quarter results themselves showed smooth sailing. Second-quarter operating profit was up 8.2% (first quarter 9.9%) while telecom services revenue was up 0.3% (first quarter 2.5%) and mobile services revenue decreased by 1.7% (first quarter up 0.3%). Management plans to ramp up its cost reduction program in fiscal 2018 lifting targeted cost reductions to JPY 120 billion from JPY 90 billion in fiscal 2017, and JPY 40 billion was achieved in the second quarter on top of JPY 34 billion in first quarter so it is on track for this full-year target. The company has changed accounting standards from USGAAP to IFRS in fiscal 2019. Management has increased its fiscal 2018 revenue forecasts slightly to JPY 4.860 trillion from JPY 4.790 trillion but retained its operating profit guidance of JPY 990 billion representing 2.1% revenue growth and 0.3% operating profit growth on the newly disclosed fiscal 2017 numbers under the new accounting standard.

Core telecom operating profit in the second quarter grew by 5.6% to JPY 258 billion representing 86% of the firm’s operating profit. NTT DoCoMo added 304,000 mobile customers this quarter with Softbank and KDDI to report over the next week. Churn remained low at 0.5% indicating that competition remains reasonably relaxed ahead of Rakuten’s planned entry into the market next year. Management also bumped up capital expenditure guidance from this year to JPY 590 billion from JPY 570 billion previously to accelerate implementation of initiatives for 5G precommercial service (JPY 10 billion) and to further reinforce its disaster preparedness in light of recent natural disasters, in particular the 2011 earthquake (JPY 20 billion over two years).

Importantly for a dividend yield stock, NTT DoCoMo has guided to a fiscal 2018 dividend of JPY 110 per share up from JPY 100 per share in fiscal 2017. In fiscal 2017, the company also spent JPY 300 billion to repurchase 111 million shares (around 2.8% of total prepurchase shares). Management has committed to another JPY 600 billion buyback to run from Nov. 1, 2018 to March 31, 2019. With the announced medium-term plan we would expect this will be well utilized. We are also now forecasting flat JPY 110 per share dividends over the next five years, instead of our previous forecast of a steady rise in dividend.