KT - KT Corp.: Regulatory Headwinds And CEO Succession In The Limelight (Rating Downgrade)

2023-04-03 09:25:22 ET

Summary

• KT faces significant regulatory headwinds regarding the potential entry of a new competitor and downward pressure on pricing.
• KT Corporation is expected to operate with an interim CEO for the next few months at the very least, as the search for a new CEO continues.
• But KT's stock is rated as a Hold rather than a Sell, as negatives are priced to a considerable extent.

Elevator Pitch

I downgrade my investment rating for KT Corporation's ( KT ) [030200:KS] shares from a Buy previously to a Hold now in view of recent unfavorable developments.

With my earlier January 17, 2023 write-up for KT Corporation, I discussed about how the digital transformation trend and the potential for raising its dividend payout could impact KT's prospects.

Regulatory headwinds and CEO succession issues are negative for KT Corporation, and this has prompted me to lower my rating for the stock to a Hold in this latest update. A Sell rating will be too harsh, considering KT Corporation's current mid-single digit P/E and low-single digit EV/EBITDA valuations.

Political And Regulatory Headwinds

In a news article published on February 15, 2023, Korea JoongAng Daily cited South Korean president Yoon's comments that "telecommunications and finance, which are government's authorized oligopolies should participate in sharing the burden" relating to inflationary cost pressures. In response to remarks made by the country's president, KT Corporation and its Korean telecommunications peers provided free data packages to their respective subscribers last month.

It is reasonable to be worried that the Korean regulatory authorities could introduce specific measures targeted at lowering telecommunications charges in South Korea going forward. These new measures might include mandating substantial price discounts for certain segments of the Korean population (e.g. the young or the elderly) or a cap on the maximum pricing for new mobile plans. On the part of the Korean telecommunications services operators like KT, they are very likely to pull back on any price hikes and also launch new budget plans to pre-empt any potential regulatory changes.

To make things worse, new players might enter the Korean telecommunications industry in time to come with the government's blessings. The Korea Economic Daily reported in the middle of February that South Korean president Yoon has the intention to "enhance competition considering all alternatives in the telecommunication sector." In other words, it isn't farfetched to expect a fourth telecommunications services operator to emerge in South Korea in due course. KT Corporation, SK Telecom ( SKM ), and LG Uplus [032640:KS] are the current three players operating in Korea's telecommunications market, and it is natural that a new entrant will increase competitive intensity, and lead to reduced sales and profitability for the incumbents such as KT.

If history is any guide, KT Corporation's shares could be potentially under pressure for a couple of months at the very least. In Q3 2017, Korean telecommunications services operators were required by regulators to increase the discount offered for new service contracts from 20% to 25%, and this resulted in KT's stock price dropping from more than $17 in July 2017 to slightly above $14 in October 2017.

Uncertainty Over New CEO Appointment

Apart from regulatory issues affecting the Korean telecommunications industry, KT Corporation is also facing company-specific challenges, more specifically relating to the company's management. KT Corporation's former CEO Ku Hyeon-mo, who led the company since March 2020, relinquished his position on March 28, 2023 after serving a three-year term.

According to a February 23, 2023 The Korean Economy Daily report , Ku Hyeon-mo didn't continue as KT's CEO for a second term, due to opposition from "KT's largest shareholder, the state-run National Pension Service, and Korean President Yoon." As highlighted by The Korean Economy Daily , The National Pension Service and President Yoon have questioned the company's "opaque process" of CEO nomination, as Ku Hyeon-mo was previously the only candidate nominated as the potential CEO for KT Corporation.

Yun Kyung-lim, who became the new CEO nominee following Ku Hyeon-mo's exit from the CEO race, resigned last week. As per The Korea Times' March 23, 2023 news commentary , Yun Kyung-lim didn't have support from the Korean government and Hyundai Motor Company ( HYMTF ) (KT's second largest shareholder) to run for CEO.

Park Jong-wook is currently KT Corporation's interim CEO, and he thinks the new CEO search will require another couple of months based on his remarks cited in a March 31, 2023 Korea JoongAng Daily article . But there is no guarantee that the new CEO candidate will be supported by KT's shareholders or the government, which means that the new CEO appointment might be even pushed back further.

At a time when KT Corporation has to contend with significant regulatory pressures (as outlined in the preceding section), it is worrying that the company has to navigate tough times with an interim CEO at the helm.

Share Price Correction And Depressed Valuations Have Largely Factored In Negatives

KT Corporation's stock price fell by -24% from its 2023 year-to-date peak of $14.88 as of January 23, 2023 to $11.34 at the end of the March 31, 2023 trading day. KT's last share price is just +1% above its 52-week trough of $11.19 recorded during intraday trading on March 30, 2023.

In terms of valuations, KT Corporation is now trading at undemanding consensus forward next twelve months' EV/EBITDA and normalized P/E valuation multiples of 2.9 times and 5.7 times, respectively as per S&P Capital IQ data.

It will be fair to say that the market has priced in headwinds for KT relating to CEO succession and regulatory issues to a large degree.

Closing Thoughts

KT Corporation warrants a Hold rating. KT's shares are cheap based on key valuation metrics, but the company is facing regulatory headwinds and a search for its new CEO is still ongoing.

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