EUR 850.00 For Business Accounts Only

Morningstar | SK Telecom’s Security Acquisitions Cover for Weaker Telecom Business. See Updated Analyst Note from 07 May 2019

SKT’s operating profit for the first quarter of 2019 was down only 0.9% after reporting a 33% decline in fourth-quarter 2018 driven mainly by strong growth in security revenue due to the ADT Caps acquisition and the consolidation of SK Infosec, SKT’s e-commerce business also reported its first quarterly breakeven at the operating profit level after many years of losses. This was offset by continued declines in its core telecom business which reported mobile service revenue decline of 6.1% and total operating income decline of 17.2%. SK Hynix, in which SKT has a 20.6% stake, also started reporting declining revenue and profit after very strong growth over recent years as the memory market turned down. Its first-quarter revenue was down 32% while its operating profit was down 69%.

While the company maintained its KRW 10,000 per share dividend for 2018, it announced at its full-year result that was reviewing 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. There was no update provided at the first-quarter result with the company indicating it was looking to balance the increase in increase in capital expenditures due to the 5G network rollout with shareholder returns. Core telecom capital expenditures is expected to increase by 30%-40% in 2019 which was about 10% more than our previous estimates.

We retain our fair value estimate at USD 27 per ADR with an increase in SK Hynix’s share price since the previous update offset by a weaker Korean Won and higher capital expenditures forecasts. Our fair value estimate implies a forward enterprise value to 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 cashflow 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.

SKT’s 20.6% owned 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. Our 2019 SK Telecom dividend forecasts stand at KRW 1,200 or USD 1.19 per ADR implying management distributes around two thirds of the SK Hynix dividend and retains the remainder to invest in 5G. With the semi-conductor memory market forecast to be much weaker in 2019 we note that consensus earnings forecasts for 2019 down around 75% on 2018 but at around KRW 5,500 per share could still see room for further SK Hynix dividend increases in the future.

SK Telecom’s fourth-quarter core mobile service revenue decline of 6.1% was much weaker than the 0.5% growth reported by key competitor, KT Corp. A turnaround in this business is important for SKT given the mobile business generates around two thirds of SKT’s consolidated revenue and until this quarter over 100% of consolidated operating profits. With the other businesses including e-commerce only reporting positive operating profit for the first time this quarter, we expect the mobile network business to be the mainstay of profit generation going forward. Security is the other business that seems to offer the biggest operating profit generation capability. After generating operating losses in the first three quarters of 2018 it jumped to an operating profit of KRW 22 billion in the fourth quarter and then KRW 32 billion in the first quarter of 2019. SKT made three acquisitions in the fourth quarter of 2018 for a total of just over KRW 1 trillion, with the largest of those, a 55% stake in ADT Caps for KRW 697 billion. We are more comfortable with acquisitions in the security as we believe the firm can better leverage its business telecom relationships and can bundle these products with its other IT and telecom offerings. The security business also generated an operating profit margin of 11.9% in the first quarter so unlike e-commerce acquisitions it is immediately contributing to profits.