Monday, April 3, 2017

A current AIM International Equity Fund holding: China Mobile (CHL) by Thomas Dietz."If CHL implements its plans - it has considerable upside"

China Mobile Ltd. (CHL, $55.23): “The King of Chinese Telcos”
By: Thomas Dietz, AIM Student at Marquette University

Disclosure: The AIM Equity Fund currently holds this position. This article was written by myself, and it expresses my own opinions. I am not receiving compensation for it and I have no business relationship with any company whose stock is mentioned in this article.

  •   China Mobile, Ltd. (NYSE: CHL) is the largest Chinese telecommunications service provider and the second largest telecom company in the world. CHL focuses on providing 2/3/4G wireless service and wireline household voice and internet service.
  •   The board has stated recently that they are focusing on sharing the company's success with shareholders, with dividends projected to increase 3% a year for the next three years.
  •    China Mobile was able to contain costs and saw a slight decrease in selling expenses of 3.9% this year, while its competitors China Telecom and China Unicom saw costs rising 4.1 and 8.4% respectively.
  •  CHL is starting to build its 5G network, with hopes of full operationality by 2020, on par with other major global telecom providers.

Key points:
The biggest recent change in China Mobile has been the advent of China Tower Corp. China Tower Corp. is a holding company jointly owned by China Mobile, China Telecom, and China Unicom. It allows the three major Chinese telecom providers to share 2/3/4G towers, cutting down massively on infrastructure costs. China Mobile is the largest owner in China Tower, with a stake over 55%.  The proliferation of China Tower will continue to help contain costs for China Mobile and allow China Mobile to reach even more customers with quality high speed mobile internet.

The majority of China Mobile's revenues are derived from its wireless customers, and CHL was able to grow its annual revenue per user (ARPU) this year, which was fortunate considering price competition has been increasing between China Mobile, Telecom, and Unicom.  China Mobile sees a 15% increase in per user revenue when the user switches from 3G to 4G, so the continued shift towards high speed mobile internet will continue to benefit CHL.  It is worth noting that China Unicom is in the process of rolling out unlimited mobile data, so China Mobile may have to respond with a similar package or risk losing customers.

China Mobile is fortunate enough to have a stable and forward looking management team, with capital expenditures strong in the regions of 5G towers, fiber broadband, the Internet of Things, and data centers.  The capex/sales ratio declined 3% from the previous year, but that was due to an increase in sales, not a decrease in capex. Looking to the next few years, China Mobile will be setting up a 5G network that will be in high demand by both mobile users and the Internet of Things, as the data packages prepared by machines on the IoT are massive and require an ultra-high speed network. Building the 5G network will require increased capital expenditures, but CHL is committed to being at the forefront of high speed next generation communication.

What has the stock done lately?
The stock has dropped ~6% in the past month, and the consensus is that the drop was due to CHL cancelling roaming fees.  With the exception of the roaming fee cancellation change, the price has been steady between $54 and $58 dollars, currently sitting at $55.23 per share.  The continued success and expansion of China Tower Corp could bolster the fairly stagnant stock, as could the increased dividends over the next few years. However, analysts across the board conclude that cannibalization within the industry is a noteworthy issue, with customers trading wireline for wireless. Price wars like those seen in the US between telecom providers are likely in the near future, and both of these issues could push the share price down.

Past Year Performance:
CHL is up 0.3% on the year, and ranged from up 15.6% in April to down 5.7% in August.  Sell side DCF models all conclude that CHL is currently undervalued, with target upsides from 10-30%.  These DCFs rely heavily on the projected increase in 4G coverage and continuing market power dominance of CHL, who serves 69% of Chinese 4G customers.

My Takeaway
CHL is likely to continue to dominate the 4G industry, but it will need to push 5G and fiber internet to stay firmly atop the Chinese market through and past 2020.  CHL's share price has been in the $50-65 range over the past five years, and the expansion and network update plans on the table have the potential to be a shot in the arm to the share price.  The mobile customer market is effectively saturated, so short term revenue growth will likely come from current customers transitioning from 3G to 4G, and long term revenue growth will likely come from 5G mobile and Internet of Things users. If CHL implements its plans in a timely and effective manner, it is poised to see that reflected in its share price.

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