Grab the throne of Moutai, how long can the telecom three giants rise?

Author | Li Xin

Editor | Liu Yang

When it comes to the three major telecom operators of Mobile, Telecom and Unicom, we can often imagine several behemoths standing in front of us, with a total of more than 3 trillion yuan. However, these three are often like water and air, everywhere, but always ignored.

Especially in the capital market, many investors are not impressed by them. For a long time, the stock prices of these giants have rarely been stable and seem to be forgotten.

However, since last November, everything has begun to reverse - the giants have gradually woken up, the stock price has risen by an average of more than 70%, and the elephant has begun to dance. For example, China Mobile's current market value has reached 2.08 trillion yuan, which is close to the stock king Maotai and ranks second in A-shares.

A major opportunity for the reversal, the market generally believes that the news from the "China Special Estimate" is catalyzed. The concept of "China Special Valuation" is the abbreviation of "valuation system with Chinese characteristics", which has attracted market attention, derived from the "exploration of the establishment of a valuation system with Chinese characteristics" proposed by Yi Huiman, chairman of the China Securities Regulatory Commission, in November last year.

Subsequently, the concept continued to ferment. First, in December 2022, the Shanghai Stock Exchange issued the "Three-Year Action Plan for Comprehensive Services for Central Enterprises", stating that "services promote the valuation of central enterprises to return to a reasonable level". On March 3, 2023, the SASAC meeting also emphasized the mobilization and deployment of state-owned enterprises to carry out world-class enterprise value creation actions against standards. In this year's government work report, it is also proposed to deepen the reform of state-owned assets and state-owned enterprises and improve the core competitiveness of state-owned enterprises.

It can be said that the proposal and implementation of the "valuation system with Chinese characteristics" is progressed by policy guidance. The soaring rise of the telecommunications three giants is exactly the three flowers that bloom under the policy soil.

However, if we pay attention to the capital market for a long time, we will know that policy is often a booster of stock prices, and whether the company's stock price can continue to rise and maintain a high level depends on the company's fundamentals.

So, can the telecom three withstand such crazy pursuit of funds, and what is the quality? Is this rally just concept hype?

1. Under the skyrocketing skyrocketing, how are the three giants of telecommunications?

Before analyzing the performance of the telecom triumvirate, let's start with a common financial indicator.

Warren Buffett said that if only one indicator could be used to choose stocks, he would firmly choose ROE. He has said on many occasions that he chooses companies with a return on equity of more than 20%.

What is ROE? In layman's terms, it is how much return a company's net worth can bring. For example, if a company invests 1 yuan and earns 0.2 yuan, then its return on net assets is 0.2/1=20%. Usually, a company that maintains a return on net assets of 15%-30% for more than five consecutive years is a very good enterprise, and Moutai's ROE has remained above 30% all year round.

Buffett chose ROE for two main reasons. On the one hand, ROE can assist in examining the ability of enterprises to convert assets into profits; On the other hand, and more importantly, we can borrow this indicator to find out whether the company has assets that cannot be recorded on the books, but provide significant support for the company's profitability, such as the company's brand, cost control capabilities, network effects and other elements.

Many times, it is these undocumented "special assets" that give companies exceptional profitability. These special assets also have two familiar names in the market: competitive advantage or moat.

If you use the ROE indicator, how are the three telecom giants performing? Suffice it to say, less than ideal.

As shown in the chart below, even China Mobile, the tallest country, has a ROE of just over 10% in 2022, while Telecom and Unicom are only 6.42% and 4.67% respectively. Unicom's ROE in 2016 and 2017 was even less than 1%.

What exactly is the reason for the low ROE of the Big Three? We can divide the return on equity into three parts to observe, namely: product net profit margin (net profit ÷ sales revenue, reflecting profit margin); Total asset turnover (sales revenue÷ average total assets, reflecting operating capacity); Leverage factor (average total assets ÷ net assets, reflecting the strength of borrowing).

First of all, the net profit margin of the telecom three giants is generally not high. In addition to China Mobile's 13.4% in 2022, China Telecom and China Unicom will only 5.75% and 4.69% in 2022.

The net profit margin is not high, which is the result of the resonance of several factors.

On the one hand, under the requirements of "speed up and fee reduction", the three major operators have reduced revenue and increased costs - we will see a high proportion of "network operation and support support", depreciation and amortization of fixed assets eroding the profits of giants, and the ARPU value (revenue generated by a single user per month) of the three major operators has generally declined.

(Note: ARPU of mobile users = average monthly revenue of operators' mobile services/average number of mobile subscribers, that is, revenue generated by a single user in a single month.) ARPU seems to have stabilized in the past two years, mainly due to the increase in the proportion of 5G users. We all know that 5G packages are more expensive than 4G. ）

On the other hand, "number porting" and relaxation of restrictions on foreign-invested telecommunications enterprises have also made the industry more competitive.

China Mobile said in its prospectus that in the field of traditional communication services, the market competition among domestic telecom operators is fierce, and the overall situation is facing unfavorable factors such as the gradual disappearance of the demographic dividend, the continuous reduction of basic communication service fees, and the substitution of some Internet applications, and the company's traditional business income pressure is greater. In the emerging field of information services, there are many manufacturers such as Internet service providers, software and application developers, equipment and solution providers, and digital content providers, and telecom giants will face more diversified competition.

What about the net profit margin in general? It can increase the total asset turnover and debt ratio.

From the perspective of total asset turnover, this indicator of the three telecom giants in the past 10 years has formed a U-shaped shape of "two highs and low in the middle", reflecting the gradual reduction of the asset operating capacity of the three companies, and then gradually rebounded, without much change.

In recent years, the total asset turnover rate has increased, and on the whole, the growth rate of income is greater than the growth rate of total assets.

On the one hand, the three companies have continued to pay dividends in recent years, which has suppressed the growth of fixed assets. In addition, the growth rate of fixed assets, the bulk of total assets, slowed down or even declined, which also dragged down the growth of fixed assets.

For example, in September 2019, China Telecom and China Unicom announced the joint construction of shared 5G base stations, and China Unicom and China Telecom will delineate areas and zoning construction, each responsible for 5G network construction in the delimited area, and share access side equipment, which can greatly reduce network infrastructure construction and operation and maintenance costs, and achieve efficient 5G network coverage, which depresses the capital expenditure of both and makes fixed assets not grow significantly.

Finally, from the perspective of leverage coefficient, the debt of the Big Three has been relatively stable in the past five years. Understandably, with slowing income growth and declining population, there is less chance of significant debt expansion unless there are significant new business growth points.

2. Why do elephants start dancing?

Since the ROE of the three companies is not high, why can the stock price rise?

Essentially, this is the result of multiple factor resonances.

First of all, although the ROE of the three companies is not high, they are still money machines, because all three companies can generate free cash flow and are relatively stable.

The so-called free cash flow refers to the money earned by the company's operating activities (net cash flow from operating activities), minus the money that must be invested in order to maintain the profitability of the enterprise (capital expenditure). It is the return that shareholders can take away from the enterprise without harming the profitability of the enterprise, and it is the only real value of the enterprise.

The generation of free cash flow provides a solid foundation for the valuation repair of enterprises.

Why do you say that? Because buying a business is itself buying a series of future free cash flows discounted to the present value, which is the basis of all business valuation.

For example, Buffett often said that the free cash flow of the stock purchased by investors should continue to be abundant, which is an important factor in determining whether the stock is worth investing in. Many people may have heard him quote Aesop's fable: "Two birds in the forest are better than one bird in hand". In his view, the free cash flow generated by enterprises is the most tangible thing investors can have.

Solid free cash flow is not enough, we also need to see that the valuations of the Big Three were not high before the launch.

Assuming that we take November 21, 2022, the day before the concept of "medium special valuation" is proposed, as an observation point, the P/E ratios of the three companies in A-shares are 12.2 times, 13.7 times and 18.7 times, respectively.

Another layer of low P/E ratio means that the inverse of the P/E ratio, that is, the "return on stock investment", is very high.

On November 21, 2022, the return on equity investment of the three companies was 8.19%, 7.29% and 5.3%, respectively, which was significantly higher than the 10-year Treasury yield of 2.88% at that time.

One private equity manager said higher stock yields meant that a group of value-biased funds had an incentive to keep buying, which would drive up their prices and bring yields closer to 10-year Treasuries.

There is cash flow, low valuation, coupled with the emergence of "medium special valuation" catalyst, which eventually detonates the stock price.

But the fund manager suggested that the Big Three can be compared with 10-year Treasury bonds, mainly because of the sustainability of the three companies' perennial profits. For companies that do not generate free cash flow all year round and whose profits cannot be maintained at a high level in the medium and long term, they cannot be simply compared with government bonds.

As of press time, the price-to-earnings ratios of the three companies are 16.55 times, 23.11 times and 24.83 times, respectively, analogous to 10-year Treasury bonds of more than 30 times, and the valuation still seems to be inexpensive. This is also interpreted by many people as the reason why the stock prices of the three companies have been able to strengthen again recently.

3. After the valuation is repaired

Overall, the recent "China Special Valuation" market, led by the three telecom giants, is not completely conceptual hype, and has certain fundamental support. But as corporate valuations continue to repair, valuations are gradually returning from the trough to rationality.

In fact, valuation repair markets similar to "medium special valuation" in the context of low valuations are not uncommon in history.

Typical example is the insurance capital market in 2016. At that time, China entered a new cycle of interest rate cuts, and from November 2014 to April 2016, the deposit rate had been cut seven times, totaling 175 basis points. At that time, short- and medium-term life insurance products represented by universal insurance became a shortcut for China's small and medium-sized insurance companies to quickly make large-scale, in order to cover the cost of liabilities and cope with the pressure of asset shortage, insurance companies invested funds in the stock market.

In 2016, Qianhai Life of Baoneng frequently listed Vanke A and CSG A with low P/E ratios, while Anbang Life twice listed Chinese buildings with low valuations in one week. In addition, Sunshine Insurance has also successively listed Yili shares and Jilin Aodong. For a time, a batch of "insurance funds raising cards" were collectively hyped. It was not until the wave of cards that triggered market doubts and the introduction of regulatory measures that the market came to an end.

For example, the "Belt and Road" infrastructure stock market launched in 2014 essentially occurred in a period of low valuation and relatively loose currency, and the market value of leading CRRC once exceeded Boeing.

However, from the perspective of the previous two market operating rhythms, although the relevant companies also have a certain valuation base, the leading companies often rise and fall, from where to go back and forth.

A number of institutional investors told "Leopard Change" that this is because in addition to value investment institutions will participate, once the stock price rises out of the trend, "K-line chart becomes good", often speculative funds will enter the market and participate in trend investment.

"But it should be noted that once the market consensus is too strong, the follow-up funds cannot be connected, and the price is easy to fall, which is similar to the speculation of theme concept stocks." A private equity fund manager said that due to the participation of speculative funds, it is easy to form negative feedback when buying is not as good as the price reversal.

In addition, the above-mentioned fund manager also said that some Chinese companies cannot generate a large amount of free cash flow every year like the telecom three giants, so their historical valuation is low, there are practical reasons, and this round of rise has a hype component. "However, we still hope that the policy guidance can make these companies more and more efficient, so that we will have more and more choices in the future layout."