KT - KT Corporation: Valuations Are Reasonable Considering Outlook And ROE

2024-01-14 06:31:57 ET

Summary

• The revenue growth for KT Corporation's telecommunications business is likely to moderate in the future due to a high 5G penetration rate and policy headwinds.
• The prospects of KT Corporation's non-telecommunications businesses, like its Enterprise DX unit and Cloud subsidiary, are good.
• KT Corporation's valuations are fair and reflect the mixed outlook for the company as a whole.

Elevator Pitch

KT Corporation ( KT ) [030200:KS] shares continue to warrant a Hold investment rating in my opinion.

Earlier, I previewed KT Corporation's financial results for the third quarter of last year and analyzed the company's shareholder return plans in my November 2, 2023 update . I outline my thoughts regarding how KT Corporation's key business units will perform in the short to medium term with the current write-up.

KT Corporation's expected ROEs for the years ahead are modest in the high single digit percentage range. I have a positive opinion of the company's key non-telecommunications businesses like cloud services, but I am less optimistic about its telecommunications business' prospects. Taking into account these factors, a 51% discount to book value is justified and supports a Hold rating for the stock.

Outlook For Telecommunications Business Is Unfavorable

KT Corporation's telecommunications operations, which include the company's wireless and fixed line business units, are expected to grow at a very slow pace in the foreseeable future.

In the most recent Q3 2023 financial period, KT Corporation's wireless revenue increased by a modest +1.6% YoY as indicated in its latest quarterly earnings presentation slides . This also translated into a -0.8% QoQ contraction in revenue for KT Corporation's wireless business unit. Moving ahead, credit ratings agency Fitch forecasts that the top line for KT Corporation's wireless division will expand at a lackluster yearly growth rate of +1% going forward.

A key factor contributing to KT Corporation's poor wireless revenue outlook is that the company has already achieved a very high 5G penetration rate.

Future growth driven by a further increase in 5G wireless subscribers is likely to be limited. At the company's Q3 2023 earnings briefing , KT Corporation shared that it has 9.51 million "5G subscriber" base that "covers 70% of total handsets." In comparison, the worldwide 5G penetration rate is projected to increase to 64% by the end of this decade as per Statista's estimates .

Also, it will be challenging for the company's wireless and fixed line business divisions to realize revenue growth by raising telecommunications charges, considering policy headwinds.

A November 9, 2023 Pulse News article mentioned that South Korea has introduced "measures to reduce household telecom expenses", which include more affordable wireless packages for youths and a higher data limit for cheaper mobile plans. Separately, The Korea Economic Daily published a news article on December 27, 2023 indicating that KT Corporation won't be increasing its "bundled telecom-OTT (Over-The-Counter) service rates" in response to the Korea regulators' push for lower telecommunications costs for consumers in the country.

But Enterprise DX Division And Cloud Subsidiary Have Good Growth Prospects

The strong growth of the company's non-telecommunications businesses such as its Enterprise DX (Digital Transformation) unit and Cloud subsidiary will help to offset the weakness associated with its fixed line and wireless divisions to some degree.

Top line for the company's kt Cloud subsidiary and its Enterprise DX division expanded significantly by +34.5% YoY and +16.1% YoY, respectively for the third quarter of 2023 as disclosed in the company's Q3 results presentation.

KT Corporation guided at its Q3 2023 results call that the company sees its cloud business subsidiary registering a "double-digit" revenue increase for both full-year FY 2023 and FY 2024. The company also revealed at its most recent quarterly earnings call that the profitability of the cloud business is better than of the company as a whole. In other words, the expansion of KT Corporation's cloud business operations will most probably translate into an increase in both revenue and earnings (a more favorable sales mix driven by higher-margin cloud services).

Apart from increasing the size of its IDC (Internet Data Center) portfolio and implementing price hikes, KT Corporation's intention to offer full-stack AI services is seen to be another key growth driver for its cloud subsidiary. In its corporate strategy presentation , KT Corporation indicated that it is "integrating all technologies, including AI infrastructure, hardware, and software, and providing them as a package" as part of its full-stack AI offerings.

The prospects of KT Corporation's Enterprise DX division are also good. At its third quarter earnings call, the company stressed that there has been a growing "digital transformation trend among our customers." As an indication of the size of the growth opportunities for its Enterprise DX unit, KT Corporation is anticipating that its "B2B (Business-to-Business) backlog orders" will exceed KRW3 trillion (or around $2.3 billion) for full-year 2023 as per its Q3 earnings briefing management commentary.

More importantly, digital transformation in South Korea has support from the government, which means that KT Corporation's Enterprise DX unit is likely to be a beneficiary of policy tailwinds. Pulse News reported last month that the Korean government has allocated KRW123.5 billion of funds to "accelerate the digital transformation of key industries such as automobiles, shipbuilding, and secondary batteries." Favorable government policies relating to digital transformation initiatives in Korea should throw up new revenue growth opportunities for KT Corporation's Enterprise DX division.

Valuations Have Factored In KT Corporation's Mixed Outlook

KT Corporation is valued fairly by the market as per my analysis.

The company's consensus FY 2023-2025 ROEs are in the 7.0%-7.3% (source: S&P Capital IQ ) range which are below the 10% ROE that I expect from an average company. As such, it is reasonable to think that KT Corporation's mixed prospects for its telecommunications and non-telecommunications businesses are reflected in the market's expectations of the company's future ROEs.

A fair P/B ratio is equivalent to [ROE minus Perpetuity Growth Rate] divided by [Cost of Equity minus Perpetuity Growth Rate] based on the Gordon Growth Model. KT Corporation's fair P/B multiple is calculated to be 0.50 times assuming a ROE of 7%, a Perpetuity Growth Rate of 2%, and a Cost of Equity of 12%. According to S&P Capital IQ's valuation data, KT Corporation is now trading at a P/B multiple of 0.49 times which is close to fair valuation.

Closing Thoughts

KT Corporation's shares are reasonably valued in view of its overall business outlook and its ROEs for the future. This explains why I have made the decision to leave my existing Hold rating for KT Corporation unchanged.

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