China Mobile: A Viable Addition To Any Dividend Stock Portfolio

China Mobile (HKEX.941) has come a long way since its listing on the Hong Kong exchange. Over the past two decades, the mainland Chinese mobile operator has been growing its business rapidly, supported by a near-unassailable leading market position in China's telecommunications market. Its mobile subscriber base is not only the largest in China, but also globally, with about 849 million customers (as of end-December 2016). The company celebrated its 20th anniversary this year with a special dividend that took its estimated dividend yield for 2017 to a mouth-watering 6.42% (as of 22 September 2017). While it is a one-off pay-out, China Mobile's dividend yield over the next two years remains attractive at approximately 4.0 – 4.5%, and is certainly a viable addition to any income-oriented stock portfolio.

Leading Player In China's Consolidated Mobile Market

Incorporated in 1997, China Mobile is a subsidiary of the state-owned China Mobile Communications Corporation. It is currently the largest telecommunications service provider in mainland China, in terms of both market capitalisation and mobile subscribers, and its operations span all 31 provinces, autonomous regions and municipalities throughout China and in Hong Kong. The company is primarily engaged in three main business segments – mobile, which brings in the lion's share of revenues and includes voice, wireless data and SMS services; wireline broadband, as well as applications and information services, which includes revenues from its content distribution, mobile payment systems and cloud computing platforms (Chart 1). China Mobile also derives a portion of its operating revenue from handset sales.

Chart 1: Largest Full-Service Telecoms Service Provider In China

China Mobile holds a leading position in China's highly consolidated telecommunications industry, ahead of its other competitors China Unicom (HKEX.762) and China Telecom (HKEX.728). The industry underwent a government-mandated restructuring back in 2008, during which six telecommunications operators were merged into the current three integrated service providers to create a more level playing field and enhance the overall competitiveness of China's telecommunications industry. While the industry shake-up led to heightened competition that took away a chunk of China Mobile's market share, its market leadership remains entrenched with a commanding 63.9% share (Chart 2), with its recent market share gains driven by its well-received 4G services, which was launched towards the end of 2013.

Chart 2: China Mobile's Entrenched Market Leadership Position

Stability And Resilience Aids Strong Dividend Track Record

China Mobile operates in an industry that is largely insulated from the economic cycle due to the necessity of telecommunications services. Moreover, consumers are also tied down by contract plans that typically last for 1 – 2 years, adding further resilience to its business. As a result, China Mobile has seen stable growth in its service revenue over the years, rising from RMB 55.9 billion in 2000 to RMB 604.9 billion in 2016 – an impressive compound annual growth rate (CAGR) of 16.0% during this period (Chart 3)!

Chart 3: Stable Top-Line Growth Over The Years

While China Mobile's recent profitability has been weighed down by increased competition, it continues to maintain a competitive advantage over China Unicom and China Telecom, with the widest distribution reach, highest average revenue per user (ARPU) and largest margins amongst the three telecommunications service providers in China (Table 1). We believe that its earnings are likely to rebound over the next few years as the company continues to gain market share and generate more revenues per customer with higher-tier 4G plans and the bundling of wireline broadband services with its existing mobile plans.

Table 1: China Mobile's Competitive Advantage Over Its Rivals

China Mobile's stability has also supported its strong dividend track record. Since its first dividend in 2002, the company has been consistently rewarding its shareholders with dividends every year, with its full-year dividend per share of RMB 2.39 in 2016 representing a healthy CAGR of 15.0% (Chart 4). It is worth noting that China Mobile's dividends look fairly sustainable at the moment, given that the company's profits have been more than sufficient to support its dividend payments, with its pay-out ratio fluctuating between 40 – 45% in recent years. China Mobile is also a highly cash generative company, whose positive free cash flows to equity have been able to cover its dividend pay-outs comfortably over the years.

While China Mobile's estimated dividend yield of 6.42% this year includes a one-off special dividend, its dividend yield over the next two years remains attractive at approximately 4.0 – 4.5%. Its cash flow situation is also likely to improve, given that management has guided for lower capital expenditures as its 4G network buildout nears completion. Moreover, with ample room to increase its pay-out ratio, a higher pay-out ratio in the future could potentially trigger a further re-rating of China Mobile's share price.

Chart 4: Strong Dividend Track Record With Healthy Earnings And Cash Flows

Balance Sheet Strength Supports Sustainability Of Future Dividends

China Mobile's dividend-paying capacity is also further supported by its strong balance sheet, with a net cash position since 2H 2003 and strong short-term liquidity, courtesy of its cash flow generation prowess. Even after paying out RMB 56.9 billion in special dividends in 1H 2017, its balance sheet remains robust, with cash on hand and term deposits totalling RMB 400 billion, an amount that is more than sufficient to cover its estimated capital expenditure of RMB 176 billion this year, as well as RMB 5.0 billion in total interest-bearing debt.

The company's prudent financial management is also reflected in its position as the only service provider with a net cash position (Table 2). Its net debt-to-equity ratio of -46.3 is much lower compared to China Unicom and China Telecom, which had net debt-to-equity ratios of 60.2 and 21.0 respectively. China Mobile also remains well-capitalised relative its two other competitors, with a current ratio of 1.12 that dwarfs China Unicom's 0.29 and China Telecom's 0.25, indicative of its ability to meet short-term obligations with ease. We believe China Mobile's strong cash position and low leverage puts it in a good stead to withstand any negative impact arising from short-term headwinds, ensuring the sustainability of its future dividend payments.

Table 2: Strong Balance Sheet Relative To Its Competitors

World's Largest Telecoms Market Has Further Room To Expand!

Despite being the largest in the world by total mobile subscribers, China's telecommunications market remains largely underpenetrated relative to developed economies such as the US and Japan (Table 3), suggesting room for further expansion as mobile penetration grows closer to that of developed markets. Moreover, the fact that only 67.4% of mobile users in China are on 4G network also underscores the growth potential of China's telecommunications market, especially as subscribers migrate to higher speed plans. The increasing adoption of fitness trackers, smart watches, and mobile payment systems, most of which rely on mobile data connectivity, as well as rising content consumption on smartphones, are also expected to drive the nation's insatiable hunger for more mobile data at faster speeds – a trend that China Mobile is well-positioned to capitalise on, given its market leadership and scale.

Table 3: Top 10 Telecoms Markets In 2016 By Total Mobile Subscribers

China Mobile's wireline broadband business, acquired from Tietong in 2015, has also been gaining momentum, with robust growth in both market share and service revenues, and is expected to be a future growth driver. The launch of its bundled service plans, along with improvements in its wireline transmission speeds and network quality, will likely drive continued subscriber growth over the next few years, while increasing customer retention.

Share Price Appears Undervalued

The valuation of telecommunications firms can be done using the EV/EBITDA multiple. The industry is generally capital intensive with high fixed costs, and companies usually borrow to fund their capital expenditures. As such, telecommunications companies are characterised by relatively high levels of debt financing. With a huge fixed asset base, their depreciation expenses also tend to be lofty. The use of the EV/EBITDA multiple to value telecommunications companies, therefore, appears justified as it is not affected by the capital structure of a company. By excluding non-cash expenses and financing costs, EBITDA is also a fairer gauge of a firm's underlying profitability.

Table 4: Valuations Of China's Telecoms Service Providers

China Mobile currently trades at an estimated EV/EBITDA ratio of 3.38 that is lower than the peer average of 3.64. Given its superior returns on invested capital and high margins relative to most of its competitors, however, we believe a valuation premium is justified for China Mobile. Assuming an EV/EBITDA ratio of 4.0 (a 10% premium to industry average) and an estimated EBITDA of RMB 270.0 billion, we arrived at an equity value of RMB 1,549.9 billion after adjusting for total debt, preference shares, as well as cash and short-term investments. With 20.5 billion outstanding common shares, China Mobile's value per share is RMB 75.60, which is approximately HKD 89.59 after converting to its trading currency, representing a 12.8% upside potential based on its last traded price of HKD 79.40 (as of 22 September 2017).

Government Regulation A Downside Risk

While the investment case for China Mobile remains compelling, it is not without its risks. The telecommunications industry in China is highly regulated and can be subjected to various policy interventions from time to time, such as government-mandated tariff reductions, that may be unfavourable to existing service providers and put further pressure on margins. Despite these concerns, China Mobile's massive market share, strong dividend-paying capacity, healthy cash flows and a lightly-levered balance sheet make this dividend stock among the best in breed. Investors can take heart that China's telecommunications market remains underpenetrated relative to the developed markets and certain emerging economies, with room for further expansion, driven by an increased demand for mobile data services.

Declaration:

For specific disclosure, at the time of publication of this report, IFPL (via its connected and associated entities) and the analyst who produced this report hold a NIL position in the abovementioned securities.

The Research Team is part of iFAST Financial Pte Ltd.