May 25, 2017 / 2:53 AM / 2 months ago

Fitch Affirms China Telecom at 'A+', Outlook Stable

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(The following statement was released by the rating agency) HONG KONG, May 24 (Fitch) Fitch Ratings has affirmed China Telecom Corporation Limited's (CTCL) Long-Term Foreign-Currency and Local-Currency Issuer Default Ratings (IDRs) at 'A+'. The Outlook is Stable. KEY RATING DRIVERS Government Support: The ratings benefit from a one-notch uplift for state support and CTCL's strategic importance to the Chinese sovereign (A+/Stable), the company's ultimate majority owner. CTCL is 71% owned by China Telecommunications Corporation (CTC), which is 100% owned by the State-owned Assets Supervision and Administration Commission. The state owns 82.85% of CTCL when all state shareholders are included. Dominant Fixed-Line Market Position: The ratings reflect CTCL's dominant position in the southern China market for fixed-line and broadband services. Its market position enables CTCL to continue offering bundled services and differentiated information, content and technology services and value-added services. Steady broadband revenue and rapid growth in its IPTV, data centre, cloud and big data businesses and projects related to the government's "internet+" strategy should continue to support fixed-line free cash flow (FCF) and help fund CTCL's mobile expansion. Fixed-line service revenue rose 2% in 2016. Solid Mobile Execution: CTCL has demonstrated exceptional execution ability despite the disadvantages of the CDMA ecosystem in 2G and 3G and delays in FDD LTE licensing. It increased its mobile service revenue share to 16% in 2016 (2015: 15%). CTCL has demonstrated success in migrating voice revenue to data revenue without harming its revenue growth. It has the biggest portion of data revenue in its mobile service revenue among the three Chinese operators. It is the second-largest 4G operator in China, with 143 million 4G subscribers (17% market share) in April 2017. Increased Broadband Competition: We expect CTCL to maintain its strong broadband market position in southern China and steady broadband revenue, despite more aggressive customer acquisition by China Mobile Limited (CML, A+/Stable). CTCL's advantages stem from its basic full coverage of the fibre network in the city areas of southern China, with 86% of its subscribers using fibre networks, which have high average access speed of over 50Mbps. The company also has dominant IPTV market share of over 70%, which help reduce churn, and a clear leading market position in data centre operations. Growth in CTCL's broadband access revenue accelerated slightly to 3% in 2016 (2015: 1%). Government-Directed Tariff Cuts: Further tariff reductions directed by the government may affect CTCL's revenue and EBITDA growth in 2017. However, we believe that the overall impact should be manageable for CTCL, as we expect to see continued favourable price elasticity. We believe this round of government-directed tariff cuts is less severe than the previous round in 2015. Chinese operators each pledged to substantially cut internet private-line access tariffs for small and medium sized enterprises, international long-distance tariffs, and from 1 October 2017, cease to charge domestic long-distance and roaming fees on their mobile subscribers. Steady Profitability: We expect CTCL's EBITDA margin to remain stable at around 27%, supporting a steady operating cash flow generation. Margin is likely to come under some pressure from the further tariff cuts and rise in operating expenses due to continued increase in tower leasing fees and higher selling and marketing expenses on subscriber acquisition. However, CTCL aims to control the overall growth in operating expenses at less than revenue growth by restricting the growth of other expenses, such as handset subsidies, general and administrative expenses, and other network operating expenses. Declining Capex: We expect capex to decline in 2017 as it trims investment in 4G. This will boost CTCL's FCF and help in deleveraging, and offset an increase in dividend payment and the effect of the tariff cuts. CTCL's 4G network utilisation rate is low, at about 26%. We forecast further capex cuts in 2018 and perhaps 2019 as we expect the strategic alliance between CTCL and China Unicom (Hong Kong) Limited (CUHKL) on network sharing plus CTCL's 800MHz re-farm for 4G use to result in more meaningful capex savings from 2018. We also believe that the majority of China's 5G capex is some years away. DERIVATION SUMMARY CTCL's standalone credit profile is weaker than that of China Mobile Limited (CML, A+/Stable), given CML's dominant market position in China's mobile market and substantially stronger balance sheet. However, CTCL's credit profile is similar to that of Singapore Telecommunications Limited (A+/Stable), whose standalone rating is 'A'. CTCL's ratings benefit from its de-facto fixed-line monopoly and leasing broadband market position in southern China, its solid mobile execution ability and its large economies of scale. CTCL's strategic alliance with CUHKL on network sharing and collaboration on new business investments and tower sharing further strengthen the company's business profile. CTCL's credit profile compares more favourably with that of KT Corporation (A-/Stable). CTCL operates in a less competitive market than KT, which is evident from the divergence in their profitability. KEY ASSUMPTIONS Fitch's key assumptions within our rating case for the issuer include: - low single-digit revenue growth in the next two to three years - EBITDAR margins at about 33%-34% in next two to three years - capex of CNY69 billion-89 billion in 2017-2020 - dividend payout ratio at around 42% RATING SENSITIVITIES Future Developments That May, Individually or Collectively, Lead to Positive Rating Action - An upgrade in the standalone rating is unlikely in the medium term due to CTCL's smaller mobile market share relative to its major competitors', lower profitability and increased competitive pressure. Additionally, as the IDRs benefit from a notch of implied government support, an upgrade in the standalone rating would not lead to an upgrade in the IDRs as they would then be at the same level as the sovereign's IDRs. Future Developments That May, Individually or Collectively, Lead to Negative Rating Action - FFO-adjusted net leverage above 2x on a sustained basis (2016: 2.2x) - Operating EBITDAR margin below 30% on a sustained basis (2016: 33%) - Weakening in linkages with the state, which we do not envisage in the foreseeable future LIQUIDITY Adequate Liquidity: Fitch believes CTCL will maintain adequate liquidity. CTCL's unrestricted cash position amounted to CNY29 billion at end-2016. While debt due within one year totalled CNY103 billion at end-2016, CTCL has support from its state-owned parent, CTC, and Chinese banks. At end-2016, unutilised committed credit facilities were CNY161 billion and about 60% of its CNY113 billion total debt was owed to its parent. Debt Structure: Total debt slightly decreased to CNY113 billion at end-2016, from CNY117 billion at end-2015. Of its total debt, a large portion was the deferred purchase consideration of CNY62 billion due to its parent, CTC, arising from the CDMA network acquisition. The deferred purchase consideration is payable in 2017. Contact: Primary Analyst Kelvin Ho Director +852 2263 9940 Fitch (Hong Kong) Limited 19/F., Man Yee Building 68 Des Voeux Road Central, Hong Kong Secondary Analyst Nitin Soni Director +65 6796 7235 Committee Chairperson Steve Durose Managing Director +61 2 8256 0307 Media Relations: Wai-Lun Wan, Hong Kong, Tel: +852 2263 9935, Email: wailun.wan@fitchratings.com. 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