The world's largest exporting country, China, has faced a series of issues over the past several years that continue to impede the country's growth in exports, not the least of which is the ongoing debt crisis in Europe. On top of that, the world's third largest economy, Japan, has recently entered into a recession and the economic situation in the U.S. remains fragile. While many investors are becoming wary of Chinese companies that are dependent on the global macro economy, China Mobile (CHL) - the world's largest carrier - represents a means to take advantage of a growing domestic Chinese economy.
Looking at the company's financial performance, CHL looks like a typical growth story. Sales, EBITDA, operating income, earnings and CFO have all grown consistently for each of the past 5 years. The stock, on the other hand, has not mirrored those results.
Looking at the 5-year chart below, the stock has not been north of $60 since 2008 despite the company's seemingly impressive financial performance. The reason for this is the threat of smaller rivals, China Unicom (CHU) and China Telecom (CHA), who carry the iPhone and operate mainly in the urban areas of China. CHL, however, still maintains a majority of the Chinese market with over 700 million subscribers. Further, the company controls 37% and 70% of the 3G and 2G markets, respectively (monthly operations data is readily available on each of the three companies' websites). Additionally, the company has unrivalled scale efficiency, the highest margins in the industry, an impressive financial position and a recognizable brand. With all that in mind, growth prospects for the company are still a considerable concern.
Given the fact that CHL and the other players in the industry are owned by the Chinese government, growth through acquisition in international markets would be extremely difficult. Growth, therefore, will have to come via the domestic economy. Although urban markets in China are quickly becoming saturated - which has compelled CHL to move into rural areas for growth where penetration is much lower - the key revenue driver for the industry moving forward will be data usage.
The most significant factor affecting the stock price at the moment is no secret; it is the company's less advanced home grown TD technology that CHL is mandated to use. The result has been a technological hurdle for adopting the iPhone and slower 3G adoption when compared with its rivals, CHU and CHA. Now, more than ever, urgency exists for CHL to get a deal done with Apple (AAPL) to increase the company's competitive position and slow the bleeding of 3G customers. As China is now the world's largest smartphone market, AAPL is neglecting an enormous opportunity by not having a deal in place the world's largest carrier. Equally, CHL needs to increase its product offerings to include the iPhone if the company is intent on winning the 3G, and eventually 4G market. When it is mutually beneficial for two parties to come to an agreement, a deal gets done more often than not. I am therefore optimistic about the two sides reaching a licensing contract soon. Of course, a deal between CHL and AAPL has been in the works for years and it is difficult to know how the negotiations behind the scenes are progressing. This has created a considerable amount of uncertainty and it is still unclear what the terms of the agreement would be.
With this in mind, and the stock's recent appreciation to almost $60, it would be prudent to wait for a more opportune moment to buy. I believe CHL is still the best positioned to perform in the industry over the long-run; however, the margin of safety is currently not satisfactory. Despite the issues highlighted above, there is so much to like about this company and the industry in general that I still see CHL as a $65 stock. Therefore, I would wait for a pullback into at least the high 40s before taking any long position.
For investors satisfied with the market's ability to correctly value securities and who are more concerned with yield, CHL is an ideal candidate with a modest dividend yield of 3.5%. The company has an impressive dividend history - dividends have grown every year for the past decade and the company maintains a 43% earnings payout target.
On a CFO and FCFE basis as well, the dividend is extremely safe and you can expect dividends to continue to grow with the company in the future.
As I would be very comfortable going long CHL at a price of $47.50, one strategy to compensate for the wait would be to write a modest amount of put options at that strike price. The ex date for the final dividend is in May, however, so expect the stock to lose about $1 at that time.
Keep in mind that successful execution of the company's 4G network in China and an agreement with AAPL are major catalysts for CHL going forward. This is a great company in an industry that still has plenty of growth potential, but the market's valuation is too inflated at this point in time. Be patient with CHL and wait for a more favourable entry point.