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Stock Strategist

Put China Mobile in Your Pocket

The undervalued carrier is set for more aggressive growth with the launch of 4G services and 5G on the horizon.

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 China Mobile’s (CHL) 2017 results were broadly in line with expectations, with service revenue up 7.2%, EBITDA up 5.4%, and net profit up 5.1%. This compares with services revenue growth of 7.1% and EBITDA growth of 5.5% for the first nine months, implying similar fourth-quarter growth rates, which is to be expected with such a large recurring revenue stream. While we would expect higher operating leverage on 7.2% service revenue growth from a telecom operator, we accept that China Mobile has been investing heavily in new revenue growth engines such as fixed broadband, corporate services, Internet of Things, and mobile payments. The quarterly profit growth is broadly in line with our full-year estimates, but we’ve reduced our forecasts slightly to account for the more competitive mobile market, now that China Unicom (CHU) is back in the game after a two-year hiatus.

We’re retaining our narrow economic moat rating but have lowered our fair value estimate to $65 per ADR from $71. This valuation implies a forward price/earnings multiple of 14.8 times and a dividend yield of 3.0% (excluding the anniversary special dividend), making China Mobile’s shares attractive at current levels, in our view. We expect the company to be able to maintain its earnings growth at mid-single-digit rates per year in the medium term. We do retain our Poor stewardship rating for China Mobile, based primarily on the company’s poor capital-management record.

China Mobile’s 2017 mobile services revenue growth of 3.8% trailed China Unicom’s 7.9% over the same period. Over 2015 and 2016, China Unicom was not very competitive in the mobile market, allowing China Mobile and China Telecom (CHA) to take share, but the market has become more competitive in the past year. With China Mobile generating around 85% of its revenue from mobile, this development is significant. Total mobile data traffic carried on the operators’ networks exploded during the second half of 2017. China Unicom’s total mobile handset data traffic jumped 107% from the first half of 2017 to the second half of 2017, to 5,253 billion MB. China Mobile’s total mobile handset data traffic jumped 61% sequentially from the first half of 2017 to the second half of 2017, to 7,738 billion MB. We see the exploding data traffic as a positive sign for the long-term prospects of all the mobile operators as customers become hooked on having access to increasing amounts of data everywhere.

One continued focus for investors is the government targets that Premier Li Keqiang outlined recently at the National People’s Congress. He indicated that China will cancel domestic Internet data roaming fees in 2018 and cut rates for mobile Internet services by at least 30% this year. While the headline numbers sound alarming, we note that China Mobile’s mobile Internet tariff has declined by an average of around 40% per year over the past two years and China Unicom’s has declined more than 60% per year. Price elasticity of demand has seen China Mobile’s mobile handset Internet access revenue grow an average of 55% per year over that period, while China Unicom’s has grown an average of 26%. Therefore, we do not see the price-reduction target as a big hurdle for the Chinese telecom operators.

The fixed-line broadband market is a different story, with China Mobile dominating the market. China Mobile increased fixed-line broadband revenue at 55% in 2017 after growing at 40% in 2016, compared with China Unicom’s flat fixed broadband revenue in 2016 and 3% decline in 2017. Given mounting pressures in the mobile market, China Mobile is focusing efforts on the fixed broadband market and having a lot of success. The company is targeting the addition of another 21 million fixed broadband customers in 2018, but it has added 7.2 million in the first two months, so this target looks extremely conservative.

China Mobile retains a very strong balance sheet, with net cash including marketable securities of CNY 470 billion ($74 billion) at December 2017. The company paid out a special dividend of HKD 3.20 per share (CNY 53 billion) in the second half, but this was offset by the CNY 57 billion received for the transfer of its tower assets to the tower company. While a full cash flow statement was not offered with the results, the presentation disclosed that free cash flow was up only 2.4% to CNY 68 billion despite capital expenditure declining from CNY 187.3 billion in 2016 to 177.5 billion in 2017, which implies operating cash flow declined around 3%. Receivables increased by CNY 12.9 billion with accounts payable declining by CNY 17.7 billion, with the company indicating the greater focus on the corporate market having an influence on this. China Mobile forecasts capital expenditure to fall to CNY 166.1 billion in 2018.

China Mobile plans 5G trials in 17 cities in 2018 and a scale commercial trial in 2019; it expects to launch commercially in 2020. However, management noted that no spectrum or licenses have been allocated and it expects standards to be finalized in 2019, so these plans are still quite fluid. While management indicated that capital expenditure was likely to continue a gradual decline in 2019, we have factored in a mild increase that year as we expect 5G expenditure to ramp up ahead of the commercial launch the following year. Management indicated that it would maintain the dividend payout ratio at 48% in 2018, and the 2017 special dividend would not be repeated.

Dan Baker does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.