Brief Equities Bottom-Up: Samsung Electronics Voluntary Red Flag on 1Q Earnings and more

In this briefing:

1. Samsung Electronics Voluntary Red Flag on 1Q Earnings
2. China Zheshang Bank – A Look Beyond Doubling Impairment Costs
3. China Mobile 4Q18 Trends Improved Slightly. It Remains Most Exposed to 5G Capex Uncertainty.
4. China Telecom Mobile Business Recovered in 4Q. Broadly in Line with Expectations
5. China Unicom Weak 4Q18 Mobile Results Offset by Strength in Fixed Line Business

1. Samsung Electronics Voluntary Red Flag on 1Q Earnings

• SamE voluntarily red flagged its 1Q19 earnings even before 1Q ends. SamE mentioned two things: 1. Falling memory chip prices and 2. slowing demand for display panels. Given the ‘usual’ profit size of DP business, this should be all about memory chips, specifically server DRAM.
• Memory chip price falling should not be enough to explain this much 1Q profit loss. It must be that SamE has decided to reflect huge inventory losses and pay bills from Amazon and Google on the book in this first quarter. Of course, SamE wouldn’t want to talk about this explicitly.
• SamE shares aren’t reacting to this a lot right now. It is mainly because local street already heavily adjusted 1Q OP to as low as ₩6.5~7tril. This 1Q earnings shock factor must have been already reflected into the price. Even below ₩6tril level wouldn’t be taken as a huge surprise.
• SamE said last month that memory sales would be revived starting 2H this year. I think this is still a valid and crucial point. This suggests that server DRAM demand from Amazon and Google will likely be back starting 3Q19. This means SamE is confident that it can handle the server DRAM optimization issue by then.
• I’m still sticking to my previous OP forecast for FY19. It should be ₩8tril more than the current street consensus. At this, SamE Common is trading at a 8.73x PER. SamE is scheduled to deliver 1Q19 interim numbers next week on Apr 5.

2. China Zheshang Bank – A Look Beyond Doubling Impairment Costs

It should be no surprise to see China Zheshang Bank (2016 HK; “CZB”) reveal a dramatic rise of impairment costs in 4Q18. It is one of only few China banks to yet announced quarterly results, and here it reported profit at -12% YoY in 4Q18.  The doubling of impairment costs in the period goes to our long-standing concerns of continued credit tdeterioration in China and well more than headline figures suggest. This is partly based on our China corporate analysis of interest cover and debt/ebitda, which remain weak. It is also notable that CZB has been one of the faster growing banks in the country, putting its ‘unseasoned’ loans higher than many others; where we believe these banks are more likely to see higher impairment costs. Perhaps that is now coming through? And with RMB250bn of write-offs in December 2018 for China’s bank system, this suggests there will have to sizeable impairment costs to replenish balance sheet provisions.

3. China Mobile 4Q18 Trends Improved Slightly. It Remains Most Exposed to 5G Capex Uncertainty.

Chris Hoare downgraded China Mobile (941 HK) some time ago on rising concerns that 5G capex would be higher than expected. While China Unicom (762 HK) and China Telecom (728 HK) both laid out very modest 2019 5G capex plans, China Mobile did not.  And despite what we saw as reasonable results, earnings guidance was weak and the lack of a rising dividend payout suggests internal concerns over 5G spending.  We had seen China Mobile as a defensive stock, but recent strong performance and rising 5G worries led us to downgrade our recommendation. It remains at Reduce with a HK$75 target. 

4. China Telecom Mobile Business Recovered in 4Q. Broadly in Line with Expectations

China Telecom (728 HK), having delivered strong revenue growth but weak margins in 3Q18, delivered better 4Q numbers. Like its peers however, the business is under some pressure with ARPUs weak despite strong data growth.  We see the Chinese Telcos as vulnerable to policy demands for accelerated 5G spending. While the market may like the look of a joint roll-out of 5G with China Unicom (762 HK), that may be simplistic. Chris Hoare thinks the cost of a combined roll-out is likely to be even higher than China Mobile (941 HK). Recent price strength makes our Reduce recommendation clearer.

5. China Unicom Weak 4Q18 Mobile Results Offset by Strength in Fixed Line Business

China Unicom’s (762 HK) recent 4Q18 results were not great. The overall figures look ok due to strength in the fixed line business which offset weakness in mobile. However, they were the weakest of the three operators and the stock, which has had a strong run, now looks due for a pause. We have turned more cautious on the Chinese telcos on concerns that 5G spending could be higher than expected. Chris Hoare believes a major reason for the Chinese telcos outperforming in the past year has come from declining capex spending expectations. That trend may now start to reverse. While China Unicom has guided for only modest 5G capex in 2019 the focus will turn to 2020 where it is a much bigger issue and while we expect China Unicom to do a joint roll-out with China Telecom (728 HK) we expect the scale of the spending to be larger than an individual build.