Chinavestor recommends a ... rating to China Telecom (CHA):

1. Profit Contributors VS Profit Crunchers

There were three main businesses that experienced significant growth during 2007. They include internet access services, value-added and integrated information application services and Leased line services and others, rising 32.1%, 35.4% and 19.9% respectively. Collectively, they contributed 34% of total operating revenues in 2007.

The internet service is the largest component of the three growing business in 2007. The operating revenue from the internet service was RMB 31,340 million in 2007, making up 23% of the total operating revenue. Broadband subscribers increased at an average rate of 1.87% monthly and had amounted to 37.71 million by the end of Q1 2008.

However, the data also shows that businesses that generate 66% of total revenue of China Telecom are falling and expected to continue the falling trend. Since the fixed-line operators are faced with fierce competition mainly from mobile operators’ free incoming call packages promotion, the monthly additions of new subscribers to local access lines have decreased at an average rate of 10.55% since 2006 and from August 2007, China Telecom started to lose its customers. This falling tendency has expedited in 2008, which resulted loss of customers totaled 3.16 million during the first three months of 2008.

The offsetting effects of all revenue sources resulted in a mere 1.7% growth in operating revenue to RMB 178,656 million in 2007. Based on quarterly unaudited performance indicators, the revenue and profit growth remain stable, indicating a pale growth prospect. The total operating revenue was RMB 44,160 million in Q1 2008, reducing 1.77% from RMB 44,957 million in Q4 2007, but an increase of 0.86% from RMB 42784 million in Q1 2007. The operating revenues excluding upfront connection fees in Q1 2008 amounted to RMB 43,646 million representing a 1.12% decrease from RMB 44,142 million for the previous quarter and a marginal increase of 1.62% from RMB 42,951 million for Q1 2007.  The profit attributable to equity holders of the company amounted to RMB 6, 251 Million, representing an increase of 18.86% from RMB 5,259 million in Q4 2007, but a 0.5% increase from RMB 6,220 million in Q1 2007.

2.     Post-restructuring opportunities

The likely industry revamp is expected to improve China Telecom’s performance as after combined with the China Unicom's CDMA mobile telephone business, China Telecom can leverage its mobile customer base to enhance its fixed-line business. It can also benefit from the 3G business that has adopted the leading 3G standard CDMA1xEVDO Rev.A. As China Mobile’s 3G services rely on the domestic 3G network TD-SCDMA, which is in a trial and technological maturing stage, if the restructuring commences in the near future, China Unicom can attract medium to high-end customers to its 3G services. The advantages of China Unicom’s CDMA over China Mobile’s TD-SCDMA include maturity of technology, ease of upgrading existing network to provide 3G service, experiences of 3G service provision, better connection and voice quality and wider ranges of compatible handsets.

3.     Valuations

The PE ratio of China Telecom is higher than the industry average, but lower for the sector average. As CHA delivered a more volatile price movement, and thus higher risks, but slow or even negative long-term growth rate, CHA should reasonably have a lower PE ratio than the industry average. Hence, CHA is currently overpriced. This may have reflected the favorable perception of the market on post-restructuring China Telecom. Before the industry revamp becomes materialized, Chinavestor recommends a ... rating.