CHINESE TELECOM SECTOR：IT IS TIME TO BELIEVE
China Shenhua Energy announced an effective 249% payout ratio with FY16results, pointing to its below peer debt to capital ratio and improving cashflowto explain the special dividend and higher regular payout. This follows CU's40% capex cut last week, suggesting SOE reform is significant forinfrastructure companies. We estimate that CT and CM's dividend yield cantheoretically reach 16% at a Shenhua like payout, and up to 45% if gearing isallowed to rise to that of Shenhua’s levels. We believe investors areunderestimating potential good news in results this week. Buy CM and CT.
How high could payout ratios go
If net debt / EBITDA was to rise to a Shenhua like 1.5x, CM can pay a specialdividend of HKD40/share, giving a total dividend yield of 45% while CT can paya HKD0.73/share special dividend, giving it a total dividend yield of 19%. If weassume payout is capped at 2.4x net profit, both CM and CT can reach adividend yield of 16%.
Why are payout ratios increasing this time around
We have discussed our thesis on why dividend payout is set to rise innumerous notes in the past 15 months, including our upgrade of CM to BUYon 14 November 2016 (“Payback by 2022 expected – Upgraded to BUY”). Ourreasons for an increase in payout include: 1) to help prop up the government’sworsening fiscal position, 2) to meet China’s promise of increasing SOE payoutto 30% by 2020, and 3) shareholder pressure to improve its returns andincrease payout ratio as capex falls. The Shenhua event reinforces this viewand given the significant dividend yield potentially on offer, we remain positiveon the Chinese telcos heading into the remaining reporting season.
Market too cynical
Recent meetings in HK, SG and EU have highlighted the considerable degreeof scepticism towards the sector. It seems minimal expectations are baked in.When we say “capex cuts”, investors say “5G”, when we say “price disciplineahead” investors say “regulation”, when we say “significant payout lifts”,investors say “flat in HKD”, and when we say “deep value & FCF growth” wehear “national service, and zero growth”. We come back to the point thatadding today’s cash, marketable securities, and FCF ahead, by 2022 this addsto the current share price at CM. It will not take much good news to see CMand CT fly we think, and we believe the signs from CU and Shenhua indicatethat a shareholder-friendly period is upon us, that investors should pay for. Weexpect the upper end of recent trading ranges is now a floor not a ceiling, andstrongly urge investors to lift positions.
Valuation and Risks
We value the Chinese telcos on DCF, using WACC’s of 7.0-8.5% and terminalgrowth rates of 0.5% (based on population growth). Key downside risks are: 1)RMB depreciation, 2) competition worsening.
□ .P.e.t.e.r. .M.i.l.l.i.k.e.n./.J.a.m.e.s. .W.a.n.g .德.意.志.银.行.股.份.有.限.公.司