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Morningstar | SK Telecom Hints of Dividend Increase for 2019; FVE Increased to USD 27

SKT’s operating profit for fourth-quarter 2018 was down 33% despite the lapping of government mandated mobile tariff cuts introduced on Sept. 15, 2017, as more customers took advantage of those tariff cuts. While the company maintained its KRW 10,000 per share dividend for 2018, it hinted at a potential dividend increase in 2019, largely to distribute some of the dividend it receives from its 20.6% stake in SK Hynix back to SK Telecom shareholders. The noncore business (ex-SK Hynix) reported an operating loss of KRW 34 billion, broadly in line with recent quarters. Given the very strong memory semi-conductor market, we note that SKT’s 20.6% stake in SK Hynix at current share price represents 46% of SKT’s enterprise value, excluding the potential capital gains tax payable should it sell the business. An investment in SKT is almost equally an investment in a memory semiconductor business and a traditional telecommunications business. We increase our fair value estimate to USD 27 per ADR from USD 25 per ADR previously on time value of money, slightly improved core business forecasts and an increase in SK Hynix’s share price. Our fair value estimate implies a forward enterprise value/earnings before interest, tax, depreciation and amortization ratio of 5.9 times with a dividend yield of 3.9%. We retain our narrow moat rating based on the core telecom business. At current prices, we see the shares as slightly undervalued. SK Telecom’s historical unwillingness to return free cash flow to shareholders is a large factor in our Poor stewardship rating on the company with the company continuing to pour investment into its noncore businesses which are largely no moat in our opinion. Depending on the significance of the dividend plan review, this stewardship rating could be reviewed.

The only guidance for 2019 provided by SK Telecom management was for revenue to grow by over KRW 1 trillion with the impact of the tariff cuts now washed through and growth forecast from other businesses including the now completed acquisitions of ADT Caps and SK Infosec. Management did indicate that it expected mobile revenue decline in the first half of 2019, but that this should turn to growth in the second half. SK Hynix lifted its 2018 dividend by 50% to KRW 1,500 per share meaning SKT will receive around KRW 220 trillion in SK Hynix dividends in 2019 which would equate to around KRW 3,080 per SKT shareholder or around USD 0.30 per ADR holder. We have increased our 2019 SK Telecom dividend forecasts to KRW 1,200 or USD 1.19 per ADR implying management distributes around two thirds of the SK Hynix dividend but note the risk is to the upside. However, with the semi-conductor memory market forecast to be much weaker in 2019, we note that consensus earnings forecasts for 2019 are half those in 2018 but at around KRW 11,000 per share could still see room for further SK Hynix dividend increases in the future.

SK Telecom’s fourth-quarter core mobile service revenue decreased by 9% as a result of government-driven tariff reductions. 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 recontracting or new customers since Sept. 15, 2017. Existing subscribers who 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. We see this change as a negative for each of the Korean operators including SKT. Service revenue has reduced which has been partially offset by reduced handset subsidy costs but we believe it is still a net negative. SKT indicated that 5G network rollout began in the fourth quarter of 2018 and did not provide a capital expenditure forecast for 2019 but did note that it could “hike slightly” with 5G. We have assumed an increase of around KRW 350 billion in 2019 from the KRW 2.1 trillion core telecom business capital expenditure in 2018.

Investors should note that SK Hynix, the semi-conductor memory company in which SK Telecom owns a 21% stake, has started to turn down after a very strong couple of years of revenue and profit increases. In the fourth quarter, the business grew revenue 10% year over year but it declined 13% sequentially, with operating profit down 1% year over year and down 32% sequentially. DRAM Exchange expects DRAM prices to fall nearly 20% in the first quarter and 15%-20% in 2019, after having experienced nine consecutive quarters of sequential price growth. NAND flash pricing is expected to be down a further 25%-30% in 2019. Consensus forecasts for SK Hynix are for a 22% fall in revenue and 49% fall in operating profit for 2019. However, with increasing demands for memory from mobile phones and data centres with the advent of big data and future demand expected from such applications as automated driving and virtual reality, the long-term outlook for the industry still looks attractive. The increased capital expenditure and know-how required to produce top shelf memory should insulate the current players from potential future competition from the Chinese for at least another five years in our opinion.