China Mobile has a very strong balance sheet with a payout ratio significantly below other wireless companies.
Strong subscriber growth and a protectionist Chinese government provide a narrow economic moat around their long-term business sustainability.
Fixed line growth has accelerated and is taking share from the largest competitors in this space – this suggests China Mobile’s market leading position is long standing.
When I read through the earnings report of China Mobile Ltd ADR (CHL) – the world’s largest wireless telephone company – I discovered a hidden gem inside and instantly thought of the “Wonderball” candy that I enjoyed as a kid. Here is an old ad for it (video). Much like a Wonderball, China Mobile is a great company with unlocked and untapped potential.
With over 880 million customers as of October 2017 (source: investor relations) and 70% of the Chinese domestic mobile services market, China Mobile is a wireless behemoth that cannot be ignored. The other major players in China are China Unicom and China Telecom which have 20% and 10% market shares, respectively.
A very important consideration for investors in CHL is the risk of government intervention in business affairs. The Chinese government is the controlling shareholder at over 70% interest. In the past the government required China Mobile to use inferior technology to compete (in an effort to create a more even distribution of customers as the government also owns China Unicom and China Telecom). Additionally, the government has implemented several policies including limiting prices and requiring data carry-over policies to hinder profitability for this wireless giant. Product revenues struggled and this could be attributed to government intervention requiring handsets to be more expensive and choices to be limited.
At first glance, this risk may scare away some investors, however, when considering how hyper-competitive the US mobile market is – an attractive multiple and high dividend yield with some protectionist benefits of the Chinese government may actually be an umbrella for long-term investors who want to combine international exposure with a strong yield.
China Mobile generates very strong cash flow combined with a whopping 71B USD cash position and very low payout ratio of 41.5%. State-owned entity reforms could pave way for future shareholder payback which would unlock tremendous value. Chinese companies have started to look towards becoming competitive on a global scale. This could be attributed to the success of Alibaba which may set an example for other strong Chinese firms.
Thus far, investor pleas to increase the payout ratio well above 41.5% has mostly fallen on deaf ears and the payout ratio for 2017 has been locked in a ratio under 50%. Compared to a large US telecommunications company such as AT&T (T) at a payout ratio of 81.5% and a PE of 17, even with half the payout ratio, the dividend yield of 5.69% is greater that AT&T with only a PE ratio of 12. Any change an increasingly popular “mixed ownership” structure in China or uptick in the payout ratio would make this stock demand a much higher PE multiple; most likely in line with or exceeding US telecommunication companies.
In the most recent earnings report for the three quarters of 2017 (report) service revenues grew over 7%, EBITDA grew nearly 6%, and net profit grew 4.6%. In subscriber growth, China Mobile has shown incredible numbers. The greatest asset of this wireless company is the gigantic customer base that it serves.
Recently China Mobile was granted permission to provide fixed-line services in late 2014. This segment has grown aggressively in the first 9 months of 2017 adding nearly 26 million customers in the first nine months of 2017.
The risk of investing in China Mobile is unique because instead of facing heavy pricing competition in a saturated market similar to the US landscape, the Chinese government is imposing their own nuances which can be more challenging to estimate and quantify. Government intervention in it business affairs is the greatest risk to China Mobile. Government control is maintained through a holding company China Mobile Communications Corp (CMCC) which owns 100% of China Mobile (HK) Group Limited, which in turn holds 70% of China Mobile with the other 30% being owned by public investors. While this governmental control is mostly a risk, the company does enjoy protectionist benefits from the government as well which helps protect against the threat of new market entrants and competition.
Based on a conservative DCF model and not factoring in any significant governmental intervention risk we came to a value of $71 per share or over a 30% upside to the current price. CHL is forming a base here around the $49 per share range and this is a great time to pick up this undervalued wireless company.
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