Telcos Entering Earnings Upcycle
The author is an analyst of NH Investment & Securities. He can be reached at jaemin.ahn@nhqv.com. -- Ed.
1. 5G subscriber-led wireless revenue growth to fuel OP expansion
Telcos entering earnings upcycle
Helped by a faster-than-expected increase in 5G penetration, telcos look to have entered a phase of wireless revenue expansion and OP growth. Given that a solid subscriber base tends result in stable profitability in the telecom industry, we expect 5G subscriber increase to push up telco earnings and share prices this year.
We expect the three domestic telcos to book combined 2021 wireless revenue ofW22.94tn (+4.0% y-y; SKT: W10.36tn (+3.7% y-y), KT: W6.74tn (+3.1% y-y), LG U+: W5.84tn (+5.4% y-y)). Backed by brisk 5G subscriber growth, these firms look to have entered an earnings upcycle since last year.
Telcos are enjoying faster-than-predicted 5G subscriber growth. While the 5G penetration rate for the three domestic telcos combined came to 9.4% at end-2019, the figure jumped to 23.6% at end-2020, and then to 28.9% in 1Q21. In particular, noting that the penetration rate maintained an uptrend in 1Q21 even amid a lack of 5G-capable smartphone launches (other than the Galaxy S21), we expect the figure to grow to 41.7% by end-2021, a level higher than the estimate from early this year.
According to data from Counterpoint, 5G smartphone shipments in Korea climbed from 5.06mn in 2019 to 8.08mn in 2020, with their portion out of overall mobile phone shipments expanding from 2.9% to 47.4%. Given that new smartphone launches should be concentrated on 5G-capable phones, consumers are likely to greater opt for 5G services, which in turn should further push up 5G subscriber figures and related penetration rates moving ahead.
2. 5G subscribers totaled 14.47mn in March; 5G penetration to reach 42% by end-2021
5G penetration rising amid expanding releases of low/mid-end 5G smartphones
As of end-March, the number of 5G subscribers at the three domestic telcos combined arrived at 14.47mn, with 5G penetration coming to 23.4%. Excluding IoT/M2M subscriptions, the 5G penetration rate reached 28.9%. Given the ongoing strong uptrend in 5G subscriptions, we expect the number of subscribers to come to 21.32mn and 5G penetration rate to reach 41.7% by end-2021, a level above the 35~40% estimated by the three domestic telcos early this year.
Of note, Apple’s recently launched iPhone 12 series works with 5G mobile networks, and most handset makers, including Samsung Electronics (SEC), are greater releasing 5G-capable versions even for their low/mid-end smartphone lineups. Given such, customers are increasingly opting for 5G price plans, a factor which is in turn accelerating 5G subscription expansion.
While 5G subscriber net addition for the three domestic telcos combined remained at a mere 520,000 on a monthly average basis in 2019, the figure upped to 710,000 in 2H20, and to 1.78mn this year. In line, the number of 5G subscribers (handset user basis) totaled 4.67mn (penetration: 9.4%) at end-2019 and 11.85mn (23.6%) at end-2020, and is projected to reach 21.32mn (41.7%) by end-2021.
We believe that a widening in indoor 5G coverage is also positively impacting consumer demand for 5G services. Of note, 5G data consumption was sized at a monthly average of around 26Gb per user as of Mar 2021. Amid an overall expansion in data consumption, consumers are greater transitioning away from LTE towards 5G networks, which deliver faster data processing.
3. ARPU to resume growing
If excluding impact from Covid 19-induced decline in roaming revenue, ARPU turned around in 2020
Having remained largely sluggish since 2016, ARPU figures at telcos are anticipated to rebound this year. Of note, the average ARPU growth at the three domestic telcos has remained in negative territory in recent years, coming in at -2.9% y-y in 2017, -7.5% y-y in 2018, -3.6% in 2019, and -0.6% y-y in 2020. But, the figure will likely return to positive territory this year, arriving at 1.4% y-y.
In 2015, as the transition from 3G services to LTE networks was nearly wrapped up, average ARPUs at domestic telcos began to downtrend. The figure further deteriorated over the following years as the discount rate for monthly plans rose from 20% to 25%. But, after introducing 5G services in 2019, the ARPU downtrend started to gradually slow, and ARPU is anticipated to resume increasing from 2021, on the back of expanding 5G subscriptions. In fact, if excluding the impact from the decrease in roaming service revenues due to Covid-19, we size ARPU growth at over 2% y-y for both 2020 and 2021. Of note, the ARPU for roaming services at the three domestic telcos currently stands at around W600.
For reference, 1Q21 ARPU arrived at W30,213 (-1.8% y-y, -0.2% q-q) for SKT, W32,003 (+0.7% y-y, +0.2% q-q) for KT, and W30,892 (+0.3% y-y, -0.1% q-q) for LGU+. For 4Q21, the figure is estimated at W30,716 (+1.7% y-y) for SKT, W32,684 (+2.3% y-y) for KT, and W31,992 (+3.4% y-y) for LG U+.
4. Marketing expenses to remain stable; impact from SKT spin-off to be limited
Telcos to further avoid excessive competition in 2H21
Telcos will likely continue to refrain from excessive marketing competition in 2H21. With competitive promotions to lure in 5G subscribers having largely ended in 2019, the three telcos’ market shares in the 5G market have remained stable (SK: 46%, KT: 30%, LG U+:23%). Given such, they are unlikely spend excessive amounts on marketing going forward.
In 2021, combined marketing expenses at the three telcos should total W8.18tn (SKT: W3.11tn, KT: W2.66tn, LG U+: W2.41tn), a level that is 4.9% higher than the W7.79tn (SKT: W2.96tn, KT: W2.52tn, LG U+: W2.31tn) seen in 2020. But, we note that handset sales plunged in 1H20 owing to Covid-19, dampening related marketing activities last year. Also worth noting, considering the impact of the adoption of new IFRS15 accounting standards in 2018, under which costs for obtaining a contract are recognized as an asset and are amortized over the expected contract period (SKT: 28 months, KT: 21 months, LG U+: 24 months), it can be said that effects from lofty marketing costs in 2019 should continue to affect telcos’ earnings in 2021. If excluding the above-noted factors, telcos’ marketing expenses are likely to remain at stable levels this year. Of note, the combined marketing costs at the three telcos arrived at W7.76tn in 2019 (SKT: W2.92tn, KT: W2.55tn, LG U+: W2.30tn).
5. Capex: Possibility of 28GHz band utilization waning; telcos’ capex riding downcycle
Smooth 5G services coverage eliminates possibility of heavy capex burden
With their 5G network investment having peaked out in 2019, we believe that domestic telecom service sector capex has entered a downcycle. In 2021, the combined capex of the three leading domestic telcos is forecast to decline 5% y-y (W2.10tn at SKT, W2.73tn at KT, and W2.26tn at LG U+). In particular, considering their smooth 5G services operations centered on major cities and large buildings, we predict that the need for large-scale 5G investment will remain subdued.
Given that the telcos wrote off 28GHz frequency band-related costs as one-off expenses, we believe that they have removed related uncertainties (by a certain degree) for the future. While we cannot say that they have given up investing in the 28GHz band completely, this recent decision reveals that they now know 28GHz-based 5G services are unlikely to materialize in the near term. We also point out that the incumbent minister of Science and ICT has commented on the difficulties involving 28GHz-based services due to a lack of service modules and handset models.
Offering services using a high-spectrum band such as 28GHz requires the installation of a lot more base stations than those for low-spectrum bands. In addition, given still high related equipment prices due to a lack of advanced equipment technologies, we believe that it will take some time before 28GHz-based services are fully commercialized in Korea. In the US, where 5G services were initially offered using the 28GHz band, most telecom service companies have now moved their 5G services onto the 3.5GHz band due to difficulties in coverage expansion.
In 2021, despite an anticipated y-y hike in depreciation expenses due to accumulated 5G investment over the past few years, we expect the overall depreciation costs at telcos to continue stabilizing. Following a sharp hike in depreciation costs in 2019 (+16.3% y-y to W7.48tn in total; W2.78tn at SKT, W2.97tn at KT, and W1.73tn at LG U+), the figure stabilized to W7.71tn in 2020 (+3.2% y-y; W2.84tn at SKT, W3.01tn at KT, and W1.86tn at LG U+) and is forecast to come in at W7.81tn in 2021 (+1.2% y-y; W2.82tn at SKT, W3.05tn at KT, W1.93tn at LG U+).