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China Mobile Upgraded on Valuation

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YLC_CHL_09Q2_tumb(Sept. 11, 2009 - Yan Ling Choo) Report is available in pdf format:  CV_CHL_2009_Q2_2.pdf

Rating: BUY

A BUY rating is recommended on China Mobile (NYSE:CHL). Despite facing a number of challenges in the past several months, China Mobile (NYSE:CHL) has managed to hold its dominant position in the world’s largest market for mobile telecommunications subscribers. Apart from the global financial crisis, the most notable challenge was the award of the TD-SCDMA license in the bid for 3G technology against competitors China Telecom (NYSE:CHA) and China Unicom (NYSE:CHU). TD-SCDMA is a homegrown technology that is not as widely used worldwide. 

Dominant Position

One of CHL’s strongest points is its significant presence as China’s leading wireless communication provider. CHL is the region’s most established in providing mobile communications. Its two competitors, China Telecom and China Unicom, fall far behind this world class giant. CHL boasts the largest number of subscribers. Therefore, it has a considerable advantage in terms of resources which could play a major role in a bid to become the 3G champion in China.

Industry Restructure

During the 3G rollout in China, CHL was granted the license for distribution of the local 3G standard TD-SCDMA. On the other hand, China Telecom and China Unicom were granted popular and widely used technologies, CDMA and WCDMA respectively. This situation presented a challenge for CHL in searching for appropriate handsets that could support its 3G technology.

Favorable Valuation

CHL has experienced positive growth rates during the last decade and is expected to continue to do so in 2009. Growth rates for net income and EPS from the past 5 years indicate that CHL is expected to grow approximately 28% in 2009. CHL also performed fairly in other valuation areas such as P/E ratio and debt-equity ratio.

Estimates (December)

2005A

2006A

2007A

2008A

2009E

Net Income (RMB millions)

54,504

66,026

87,062

112,793

144,651

EPS

2.71

3.32

4.35

5.63

7.19

EPS Change (YoY)

28%

23%

31%

29%

28%

Dividend / Share

1.02

1.54

2.10

2.74

3.92

 

Key Financial Data China Mobile Limited (NYSE:CHL)

Key Income Statement Data

2005

2006

2007

2008

(RMB, millions)

Total Revenue

249,576

295,358

356,959

412,343

Total Operating Expenses

(171,855)

(203,433)

(232,891)

(269,728)

Operating Profit

77,721

91,925

124,068

142,615

Net Finance Costs

(1,346)

(1,510)

(1,825)

(1,550)

Profit Before Taxation

78.489

96,176

129,238

149,743

Tax Benefit/ (Expense)

(23,945)

(30,062)

(42,059)

(36,789)

Profit for the Year

54,544

66,114

87,179

112,954

Key Cash Flow Statement Data

2005

2006

2007

2008

Net Cash from Operating Activities

131,709

149,346

168,612

193,647

Net Cash used in Investing Activities

(87,116)

(118,841)

(123,039)

(139,026)

Net Cash used in Financing Activities

(25,173)

(23,587)

(37,276)

(45,684)

Net Change in Cash and Cash Equivalents

19,312

(6,706)

(7,692)

(8,567)

Key Balance Sheet Data

2005

2006

2007

2008

Cash & Equivalents

64,461

71,167

78,859

87,426

Total Current Assets

123,736

171,507

207,635

240,170

Property, Plant & Equipment

252,563

270,710

304,590

363,265

Total Assets

385,618

494,676

563,493

657,697

Total Current Liabilities

109,954

140,607

154,953

180,573

Long-Term Debt

12,912

9,941

9,949

9,920

Total Liabilities

148,366

175,674

189,742

215,419

Total Equity

237,252

319,002

373,751

442,278

Total Equity & Liabilities

385,618

494,676

563,493

657,697

Market Comparisons

Company

Industry

Sector

S&P 500

P/E Ratio (TTM)

12.31

13.63

11.08

40.79

Beta

0.95

0.47

0.53

1.41

Dividend Yield

3.46

0.16

0.19

1.53

Payout Ratio (TTM)

42.94

45.97

36.33

88.25

Sales (MRQ) vs Qtr. 1 Yr Ago

8.93

(6.13)

(4.35)

(5.72)

Sales (TTM) vs TTM 1 Yr. Ago

11.13

(5.90)

(3.79)

(1.60)

EPS (MRQ) vs Qtr 1 Yr. Ago

1.78

(13.73)

(10.08)

(24.08)

Current Ratio (MRQ)

1.28

1.65

1.42

0.91

Total Debt to Equity (MRQ)

2.34

21.07

50.36

235.71

Asset Turnover (TTM)

0.64

0.68

0.55

0.46

Return On Assets (TTM)

16.85

7.11

5.06

3.57

Return On Equity (TTM)

25.80

10.65

8.61

9.11

Gross Margin (TTM)

94.03

61.00

52.60

24.87

Operating Margin (TTM)

33.31

17.83

12.77

--

Pre-Tax Margin (TTM)

35.12

16.61

12.02

7.12

Net Profit Margin (TTM)

26.47

10.16

7.59

5.78


Summary

In January 2009, China underwent a major restructure in the mobile communications services industry with the introduction of 3G technology. China Mobile was awarded the license to operate using the homegrown 3G standard, TD-SCDMA. Its competitors, China Telecom and China Unicom were granted licenses for more common and widely used 3G standards, CDMA and WCDMA. With this, came the challenge for China Mobile to maintain its dominance as the world’s largest wireless communications service provider. Thus far, China Mobile has managed to sustain its significant customer base with the offerings of appropriate handsets. It has also managed to fare favourably in a range of valuation ratios in comparison with industry wide valuations. China Mobile performance in the future looks positive for now, but is partially dependent on how it attracts popular handset providers to comply with the 3G standard and therefore increasing the number of subscribers.

Recommendation: BUY

  1. Industry Dominance

CHL’s revenues have consistently increased since its incorporation. However, CHL experienced its lowest growth rate in 2008 of 16%, declining by 5% from 2007. This could be attributed to the difficulties faced during the major change in China’s mobile telecommunications industry.

Chart 1: Revenue and associated growth rate 1997-2008
YLC_CHL_09Q2_1

Operating profits have accounted for at least 30% of total revenues since 2004. Revenues are mainly contributed by increases in value-added services such as caller ring tone, call waiting and multimedia message service. However, providing these services has incurred significant operating expenses, causing the portion of operating profits to grow only marginally. Apart from increasing revenues, CHL’s ability to drive down costs plays an important role in maintaining its financial standing.

Chart 2: CHL Operating Profit and Operating Expenses 2004-2008
YLC_CHL_09Q2_2

Established Customer Base

The portion of GSM subscribers for CHL, China Telecom (CHA) and China Unicom (CHU) shows that CHL continues to dominate with the highest number of customers. However, it is important to note that China Telecom’s market share has increased by 1% (an equivalent decrease in CHL subscribers) in 4 months.

Chart 3: GSM subscribers as of April 2009 Chart 4: GSM subscribers as of July 2009
YLC_CHL_09Q2_3 YLC_CHL_09Q2_4

Dominance of China Mobile (NYSE:CHL) is due to its well established specialization in mobile communications, especially in areas of the region not covered by other providers. Prior to the 3G rollout, China Telecom’s business more heavily relied on fixed lines and broadband services. China Unicom is relatively new compared to these two.

In order for CHL to maintain and grow its share of subscribers, it has to fully utilize its first mover advantage in providing mobile coverage in the rural areas. Such areas present a large untapped market of mobile users which CHL could develop.

Introduction of 3G presents Challanges

Handsets

The biggest challenge faced by CHL in the face of the 3G rollout is to source compatible handsets to support its TD-SCDMA technology. Most handsets available outside the region supports the CDMA and WCDMA technologies held by China Telecom and China Unicom.

This has lead to CHL’s introduction of the Ophone, a locally developed touch screen phone that meets current trends. Previous negotiations with Apple to market Iphones under the CHL’s 3G standard did not come through. Instead, Apple made a deal to enter the market through China Unicom. However, the deal is not exclusive, and Apple and CHL could come to an agreement in the future.

CHL will be offering handsets in cooperation with HTC, Dell and Lenovo. CHL continues to source for the latest handsets that will supports TD-SCDMA to satisfy current subscribers’ need for style and functionality as well as attracting potential long term subscribers.

Coverage

CHL already provides wide 2G coverage in rural areas which its competitors lack. This could flow over to its efforts to be the main provider of the 3G technology in those areas. Existing subscribers expect better quality from CHL which it should be able to deliver.

The success of CHL lies in developing the TD-SCDMA technology to ensure good connection at low prices. With the development of handsets to suit its own Ophone platform and homegrown OS as discussed above, cost can be reduced and mobile packages can be offered at lower prices.

Heavily subsidized subscriber plans will also assist in gaining customers in rural areas.

Financial Performance

CHL

CHU

CHA

Price to Sales (TTM)

3.26

1.19

1.47

Dividend Yield

3.40

2.08

2.06

Dividend Yield – 5 Yr Avg

2.09

1.60

2.11

Dividend 5 Yr Growth Rate

44.75

14.87

4.23

Sales (MRQ) vs Qtr 1 Yr Ago

8.93

(31.39)

14.13

Sales- 5 Yr Growth Rate

17.25

17.26

4.27

EPS (MRQ) vs QTR 1 Yr Ago

1.78

(61.35)

(28.74)

EPS- 5 Yr Growth Rate

22.53

(6.91)

(47.87)

Gross Margin (TTM)

94.03

61.85

80.17

Gross Margin - 5 Yr Avg

90.95

79.03

75.01

Operating Margin (TTM)

33.31

6.32

0.36

Operating Margin- 5 Yr Avg

32.85

10.58

17.85

Net Profit Margin (TTM)

26.47

4.84

(1.32)

Net Profit Margin – 5 Yr Avg

23.99

7.07

12.41

Return on Assets (TTM)

16.85

3.67

(0.63)

Return on Assets - 5 Yr Avg

16.19

3.89

5.21

Return on Investment (TTM)

23.98

5.76

(1.00)

Return on Investment- 5 Yr Avg

22.50

5.98

8.30

Return on Equity (TTM)

25.80

6.03

(1.25)

Return on Equity – 5 Yr Avg

25.23

7.78

11.10

Quick Ratio (MRQ)

1.26

0.20

0.27

Current Ratio (MRQ)

1.28

0.21

0.29

LT Debt to Equity (MRQ)

2.10

3.86

11.18

Total Debt to Equity (MRQ)

2.34

14.74

49.22



The price to sales ratios show that CHL’s ratio is higher than that of China Telecom’s and China Unicom’s. This means that for every dollar of sales generated, the market places a higher value on CHL shares. However, it does not mean that CHL shares are necessarily a better investment, but that it is currently more expensive compared to competitors.

Dividend yields show that CHL stocks are faring rather well for its investors. The 5 year average and its steep growth rate show that CHL’s generous payout started only recently.

Sales for the current quarter compared to the same period a year ago underperformed compared to China Telecom (NYSE:CHA). However, the 5 year growth rate implies that increase in sales for China Mobile (NYSE:CHL) is more consistent than China Telecom (NYSE:CHA).

CHL has generated higher earnings this quarter compared to the same quarter last year. Growth rate from 5 years ago shows a significant increase. On the contrary, both competitors have experienced a decrease in EPS.

Profitability ratios show that CHL performs well in every aspect. Similarly, ROA, ROI and ROE show that CHL has been effectively managed and produced appropriate levels of turnover.

CHL’s is also very strong financially, as indicated by quick, current and debt related ratios. These ratios indicate that CHL is capable of meeting short term and long term obligations without much difficulty.

4. Estimates

Period

2004

2005

2006

2007

2008

2009 E

Net profit (RMB millions)

41,749

54,504

66,026

87,062

112,793

144,651

EPS

2.12

2.71

3.32

4.35

5.63

7.19

EPS change

28%

23%

31%

29%

28%

Dividend

0.66

1.02

1.54

2.10

2.74

3.92


During the previous 5 years, net income, EPS and dividend payout have been growing consistently. Therefore, it is expected that 2009 will be no different, despite challenges faced in the industry within the region. CHL is expected to be able to overcome any difficulties mainly due to its financial standing which allows it to finance less profitable activities now for the long term.


Table 1: Financial Summary, 2004-2008

RMB million

2004

2005

2006

2007

2008

Operating revenue

Usage fees

128534

156710

189710

226488

260889

Monthly fees

24760

25055

21629

20856

18096

Value-added services fees

30236

50187

69309

91609

113444

Other operating revenue

8851

11089

14710

18006

19914

192381

243041

295358

356959

412343

Operating expenses

Leased lines

3861

3224

2451

2330

2641

Interconnection

12072

15309

18783

21500

22264

Depreciation (Note 2)

44186

56368

64574

67354

71509

Personnel (Note 2)

9972

14200

16853

18277

19960

Other operating expenses (Note 2)

62811

80254

100772

123430

153354

132902

169355

203433

232891

269728

Profit from operations (Note 2)

59479

73686

91925

124068

142615

Amortization of goodwill

(1930)

Other net income

3167

3284

2872

2323

2159

Non-operating net income

548

499

285

657

517

Interest income

1014

1615

2604

4015

6002

Finance costs

(1679)

(1346)

(1510)

(1825)

(1550)

Profit before taxation

60599

77738

96176

129238

149743

Taxation

(18828)

(24149)

(30062)

(42059)

(36789)

Profit for the year (unadjusted)

41771

53589

66114

87179

112954

Equity shareholders of the Company

41749

53549

66026

87062

112793

Minority interests

22

40

88

117

161

Profit for the year (unadjusted)

41771

53589

66114

87179

112954


Table 2: Assets & Liabilities, 2004-2008

RMB million

2004

2005

2006

2007

2008

Property, plant and equipment (Note 2)

212459

216505

218274

257170

327783

Construction in progress (Note 2)

30510

34201

52436

47420

35482

Land lease prepayments (Note 2)

6333

7243

7675

8383

10102

Goodwill (Note 2)

35300

35300

36894

36894

36894

Other intangible assets

700

469

298

Interest in associates

Interest in jointly controled entity

7

Deferred tax assets

4068

6625

7113

5445

6884

Other fi nancial assets

77

77

77

77

77

Deferred expenses

96

Net current assets/(liabilities)

(17757)

11122

30900

52682

59597

Total assets less current liabilities

271086

311073

354069

408540

477124

Interest-bearing borrowings

(36633)

(36545)

(33574)

(33582)

(33553)

Deferred revenue, excluding current portion

(944)

(1324)

(930)

(597)

(584)

Deferred tax liabilities

(105)

(97)

(192)

(122)

(80)

Net assets

233404

273107

319373

374239

442907



Analyst Certification

I, Yan Ling Choo, hereby certify that the views expressed in this research report accurately reflect my personal views about the subject securities and issuers. I also certify that no part of my compensation was, is, or will be, directly or indirectly, related to the specific recommendations or view expressed in this research report.

Copyright, user agreement and other general information related to this report:

Copyright 2009 Chinavestor.com. All rights reserved. This research report is prepared for the use of Chinavestor.com clients and may not be redistributed, retransmitted or disclosed, in whole or in part, or in any form or manner, without the express written consent of Chinavestor.com.

This research report provides general information only. It is not intended to provide personal investment advice and it does not take into account the specific investment objectives, financial situation and the particular needs of any specific person who may receive this report. Investors should seek financial advice. Past performance is not necessarily a guide to future performance.

Fundamental equity reports are produced on a regular basis as necessary to keep the investment recommendation current.




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