Chinese Telecoms:Some risks emerging but we remain constructive

Deutsche Bank Markets Research Asia China Telecommunications Industry Chinese Telecoms Date 29 November 2017 Forecast Change Some risks emerging but we remain constructive Sector risk manageable... CU our top pick on stronger momentum ________________________________________________________________________________________________________________ Deutsche Bank AG/Hong Kong Deutsche Bank does and seeks to do business with companies covered in its research reports. Thus, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. DISCLOSURES AND ANALYST CERTIFICATIONS ARE LOCATED IN APPENDIX 1. MCI (P) 083/04/2017. James Wang Research Analyst (+852 ) 2203 6145 james-z.wang@db.com Peter Milliken, CFA Research Analyst (+852 ) 2203 6190 peter.milliken@db.com Key Changes Company Target Price Rating 0728.HK 5.40 to 4.55(HKD) - 0762.HK 14.80 to 15.50(HKD) - Source: Deutsche Bank Top picks China Unicom (0762.HK),HKD11.60 Buy China Mobile (0941.HK),HKD80.35 Buy Source: Deutsche Bank Companies Featured China Telecom Corp (0728.HK),HKD3.79 Buy 2016A 2017E 2018E P/E (x) 14.6 13.4 12.6 EV/EBITDA (x) 3.7 3.6 3.2 Price/book (x) 0.8 0.8 0.8 China Unicom (0762.HK),HKD11.60 Buy 2016A 2017E 2018E P/E (x) 291.6 62.6 33.2 EV/EBITDA (x) 4.2 3.8 3.2 Price/book (x) 0.8 0.9 1.0 China Mobile (0941.HK),HKD80.35 Buy 2016A 2017E 2018E P/E (x) 14.2 12.2 11.5 EV/EBITDA (x) 4.4 3.4 3.2 Price/book (x) 1.5 1.4 1.4 Source: Deutsche Bank The Chinese telcos have delivered solid top-line growth this year (6%) but have been casualties of risk-on trade. While competitive intensity increased following the launch of CT’s RMB99/mth unlimited data plans in September, we do not believe the sector will engage in cut throat competition at this stage, in view of its orderly behavior to date. M&A risk also recently came to the fore, with CT looking to acquire a near bankrupt Oi, although if this goes through, it would most likely occur at the parent level. While we still like CM, whose next likely major catalyst is in 1H18, we change our top pick to CU, where revenue momentum is improving and cost control is better than at peers. Sector remains in good condition The sector remains in good condition with revenue growth accelerating to 7% in 3Q and free cash flow set to improve in the next few years from capex reductions. While cost management at CM and CT has been less than desirable this year, maintenance cost growth should ease as soon as the network roll-out slows. On pricing and competition: we are encouraged by the top-line growth spurred by unlimited data plans that have been introduced so far but remain watchful for possible deterioration in pricing levels from here. CU now our top pick on cost control and better-than-expected top-line growth CU is now our top pick for its better-than-expected revenue momentum, with 3Q revenue growth rising to 6% YoY from 2% in 1Q and 4% in 2Q. Cost management has also been strong. EBITDA margin has improved 60bps YTD and we see prospects for further margin improvement as CU consolidates more of its various business divisions. With better growth prospects and a focus on cost control, which could see capex to sales ratio in line with regional peers over the next 3 years, we see significant re-rating potential as CU trades at 3.9x FY17E EV/EBITDA vs a regional average of 6.5x. We still like CM but major catalyst likely to occur only in 1H18 CM is a close second in our pecking order for its cheap valuation, market leading position, prospects for future dividend increases and strong earnings power. It should also benefit from risk-off trade, given valuation support and a vast cash holding (HKD24/share). That said, the next re-rating catalyst could be some time away, most likely in 1H18, when we expect CM to announce a special dividend on receiving cash from the towerco. Some concerns for CT but valuation remains supportive We have more concern for CT post the 3Q results including: 1) weaker cost control with EBITDA growth of 3.7% YTD vs peers avg of 5.7%, 2) risks from a stronger CU, particularly in the enterprise segment, and 3) the Oi deal though it is more likely to occur at a parent level. While we have made reductions to our earnings forecasts to reflect the above, CT’s valuation remains supportive with the stock trading 1 standard deviation below its long run average EV/EBITDA. Valuation and risks We base our sector valuation generally on a DCF approach, which we apply due to the relatively predictable cash flow profiles of Chinese telcos. We use a 7.5% WACC for China Telecom and China Mobile, and an 8.4% WACC for China Unicom. We use 0-0.5% perpetu