Telcos Expected to Enjoy ARPU Growth in 5G Era
The author is an analyst of Shinhan Investment Corp. He can be reached at mj1224@shinhan.com. -- Ed.
Recommend OVERWEIGHT on telecom service sector with LG Uplus as top pick
We initiate our coverage on the telecom service sector with an OVERWEIGHT rating. The three telcos under our coverage will likely see top-line growth going forward by upselling mobile plans for 5G services. Domestic telecom stocks are currently trading at a 2020F PER of 10.8x and EV/EBITDA of 3.6x vs. the global peer average of 14.6x and 5.5x. Valuation discounts on domestic telcos were seen reasonable in the past due to excessive marketing competition and government regulation on fee plans. However, we believe valuation discounts will gradually narrow as the sector enters the 5G era.
In 2019, domestic telcos launched the world's first 5G services after aggressively investing into 5G networks. Unlike global peers, capex spend by domestic telcos is projected to decrease slightly going forward after reaching a peak in 2019. We expect to see limited marketing spend in 2020, with telcos less focused on attracting subscribers following heated competition at the start of 5G services. The companies are unlikely to spend too much on marketing as consumer needs for 5G are seen limited at this point. We recommend LG Uplus as our top pick in the telecom service sector. Investment points are: 1) larger market share in 5G services vs. total telecom services; and 2) growing presence in the pay TV market thanks to reinforced content competitiveness. In addition, holding company LG Corp has been purchasing shares in LG Uplus, creating favorable supply-demand conditions for a share price rally.
Mobile telecom: Top-line growth expected in 5G era
The three telcos under our coverage are expected to enjoy ARPU growth in the 5G era. Average ARPU will likely reach KRW32,690 by end-2020, increasing 3.2% from KRW31,663 in 4Q19. The shift to 5G services has been disappointingly slower than the transition to LTE. However, we are positive on easing marketing competition. Telcos should see growth in 5G subscribers without excessive marketing efforts once replacement demand increases on the expiration of mobile plans along with the launch of various types of 5G smartphones. We also expect commercialization of mmWave and standalone (SA) 5G networks within 2020, which should help consumers notice improvement in speeds compared with LTE. The number of 5G subscribers should reach 11.5mn at end-2020, boosting the 5G penetration rate to 16.2%.
Pay TV market: Growing presence of telcos
Telcos have already established a strong presence in the IPTV market, thanks to relative strengths vs. cable system operators backed by nationwide networks and a wider selection of high-resolution videos for VOD services. They are further expanding their market share through M&As. With the combined market share reaching 80% after recent M&As, the telcos will likely have larger bargaining power in negotiating transmission fees with home shopping companies. VOD revenue should continue to grow on increased consumer adoption of paid content and reduction in outdoor activities amid the COVID-19 pandemic.
Domestic telcos to record YoY OP growth in 2020
The three major telcos are forecast to post combined operating profit of KRW3.15tr (+7% YoY) for 2020. They should all see operating profit increase on a YoY basis, backed by: 1) full-fledged launch of 5G mobile services; 2) solid top-line growth from media services (IPTV, etc.); and 3) stabilization in marketing expenses as a percentage of sales to less than 15% on easing competition. We estimate operating profit growth at 11.8% YoY for LG Uplus, 8.9% YoY for SK Telecom, and 2.7% YoY for KT.
Issues: Favorable regulations, high dividend yields and foreign fund outflows
The regulatory environment has become more favorable than in the past. The negative impact from unfavorable regulations introduced in 2017 (selective contract discount rate raised to 25%, rate cuts for low-income users, etc.) has already been reflected in earnings. The Korean government is unlikely to place rate-related restrictions in the near term as it is encouraging telcos to expand 5G network investments in 1H20 to help overcome pandemic-sparked economic difficulties. The recent share price correction has driven up dividend yields of domestic telcos to an average of 4.3% vs. the KOSPI average of 2.4%. Meanwhile, we are currently witnessing an outflow of foreign funds from the domestic stock market. However, the telcos should be among the first to see recovery in liquidity given forecasts for profit growth on 5G deployment and high dividend yields.