CHT - Chunghwa Telecom Mid-Year Review

2023-08-16 18:19:07 ET

Summary

• I discuss the investment thesis of having telecom companies in the portfolio that can withstand economic downturns.
• I analyze the financial performance of Taiwan's Chunghwa Telecom, highlighting its growth in revenue and net income.
• Chunghwa Telecom should improve its dividend payout ratio and I discuss the risks associated with the relationship between China and Taiwan.

Investment Thesis

There are certainly risks that the world is going to enter a recession, mild or otherwise, in the very near future.

We believe that it is wise to have some companies in the portfolio that historically have been able to stand up to such economic downturns. Data clearly points to consumers all over the world "tightening their belts" and trying to spend less.

Businesses that make a living from selling you the things that you really can't live without tend to do better than those that provide things which are nice to have, or do, but really not necessary.

Mobile phones, or cell phones as they are called in the U.S., clearly fall into the category of things you really cannot live without. According to recent data from DataReportal, the average person spends 3 hours and 15 minutes on their phone each day, with 20% spending more than 4.5 hours on average on their phones every day.

We have two great telecom companies in our portfolio, which is China Mobile ( CHL ) and Singtel ( SGAPY ), but are always interested to explore other candidates, preferably of similar caliber.

One of the telecom companies we do cover here in SA is Taiwan's Chunghwa Telecom ( CHT )

In our previous analysis of CHT, "Taiwan's CHT Is Growing Earnings" we continued our Hold stance as we concluded that its share price was too expensive compared to its Asian peers, and the increasing geo-political tension around China and Taiwan does certainly dampen investors' appetite for investing in it.

CHT has just come out with its Q2 financial results , and it is a good time to see if the financial fundamentals in relation to its share price have improved, and we will revisit the risks to our thesis.

FH 2023 Financials Results

On the top line, we did see CHT managing to grow the revenue by 3.8% from NT$103.7 billion in FH last year to NT$107.7 billion (equivalent to about USD $3.44 billion) this year.

The net income grew by 4.6% in FH 2023 to NT$19.6 billion. This translates to an EPS of NT$2.52

Assuming the EPS in SH of the year is in line with FH, they should easily beat last year's EPS for FY 2023. The EPS has grown slightly over the last year, however, what is more interesting in the context of a potential recession is the resilience CHT showed during the pandemic.

Here is the history of both the EPS and the dividend over the last couple of years.

Despite the steady growth in EPS, we can see that their dividend has not kept up with the growth in earnings.

A payout ratio of 31.4%, as it was last year, is low when compared to that of Singtel. Their dividend policy is to distribute 60 to 80% of underlying net profits.

We would like to see CHT improve its dividend payout ratio, especially in view of the fact that most of the Capex involved in rolling out 5G is now done.

In terms of P/E, the gap between CHT and SGAPY is also still quite considerable.

A positive element is CHT's ability to grow its ARPU on a Y-o-Y basis.

More important than earnings is free cash flow.

CHT's free cash flow after Capex in FH 2023, was NT$16.7 billion. That is up 6.9% Y-o-Y.

On to the balance sheet.

Now that FH results for most of the companies in our portfolio are out, we have noticed that the increased cost of financing has dented the profits for some of the companies. It is in times like these, that we as investors are reminded that financial discipline and prudence are vital to any business.

CHT seems to be prudent, as their debt ratio, defined as the ratio of total debt to total assets, is a comfortable 28.9%

Long Term bank loans are only NT$1.6 billion. They pay 1.91% interest on this loan. Taiwan's central bank's interest rate is still very low at only 1.875%.

In addition, they have bonds payable worth NT$30.48 billion with very low coupons and no bonds maturing before 2025. Here is their bond maturity profile;

Risks to thesis

The obvious risk is the big elephant in the room. That is the People's Republic of China.

When we do risk assessments, we need to carefully consider what we believe is the probability and the severity of any action that would cause harm. In investing, that is a loss.

The severity of losses to CHT in the event Taiwan would experience what Ukraine now is going through is obviously very high. Shareholders could potentially lose all in a scenario like this.

The probability is very difficult to determine. We can all have an opinion based on what we hear and know. Almost two-thirds of the people of Taiwan believed, as of a survey conducted in October 2021 that they did not think there would be a war between China and Taiwan. People's perceptions of things can change overnight.

We do not think it will come to a war, because here the stakes are high and this "elephant" does not want to be seen as an aggressor. As such, we believe the likelihood is very small.

Conclusion

It is good to see that CHT is growing its earnings, and at the same time, keeping its balance sheet in good shape.

We would like to see them distribute dividends more generously. A yield of 4% is not exactly something to get too excited about. Especially in an interest rate environment that offers investors risk-free returns north of 4%.

Should investors not be compensated higher since the risk of a further deterioration in the relationship between China and Taiwan cannot be ruled out?

Are shareholders sufficiently paid for this risk?

We think not and look forward to hearing what the SA community thinks.

Our Hold stance remains

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