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China Comservice（552.HK）- Growth has reached the ceiling!

Thursday, October 15, 2009

5801

China Comservice(552)

Recommendation on 15 October 2009
Recommendation	HOLD
Price on Recommendation Date	$4.330
Target Price	$4.500

Weekly Special - 358 JIANGXI COPPER

Summary

China Communications Services Corporation Limited (CCS or the company) is a company holding by China Telecom Group with main business of telecommunications network construction, maintenance, operation to the provision of services to users, forming an industry chain of communication service sector except hardware. China Mobile Group and China Unicom Group also have shares in this company.

As 3G investments by domestic operators has passed the peak, we think the company has already entered into its mature stage in which stable and considerable dividend yield is critical for attracting long term investment. Given its not strong overall valuation attraction, we rate CCS “Hold”, with 12-Month TP of HK$4.50, meaning 3.03% dividend yield in FY2010.

Strong 1H09 growth largely in line with consensus

The company recorded revenue growth of 31.7% and net profit growth of 33.3% y/y in 1H09, slightly higher than the 30% of market expectation. Specifically, Telecom infrastructure service (TIS), Business process outsourcing (BPO) and Applications, content and others (ACO) contributed 65.4%, 33.7% and 0.9% to the growth respectively.

Despite the strong growth y/y, its real operating performance growth is unsatisfied. Excluded the contribution from China International Telecom Construction Corporation (CITCC) (Recorded into the consolidation sheet from Jun 2008), the 1H09 sales increased 24.6% y/y while net profit growth declined to 25.5%. Meanwhile, the total revenue dropped 4% h/h, and net profit only added 1% h/h including the contribution from CITCC.

As 3G investments by domestic operators has passed the peak, and the comparative base of 2H08 is high, we think the company's revenue growth y/y in 2H09 will be probably less than 10%, suggesting the full years` growth below 20%.

Business structure continues to be adjusted, profitability sustains stably

Being affected by the domestic issuance of 3G license, the business structure of CCS continues to be adjusted. Above all, the proportion of TIS income in 1H09 has increased 5.5pts over 1H08, due to the largely increasing amount of domestic operators` CAPEX. Secondly, the revenue from maintenance business has raised 68.9% y/y, its proportion of the BPO has been increasing to 20.2% from 14.8%, and it has become the fastest sub-business in CCS. Lastly, revenue proportion from China Unicom (CU) and China Mobile (CM) has gone up 4.5pts, whereas that of China Telecom (CT) also increases 1.1pts.

In terms of profitability, the declining raw materials cost hedges the increasing labor cost. Thus, the gross margin of CCS in 1H09 sustains stably, but falls 1pts h/h. We expect that the whole gross margin of CCS in 2009 may be lower than that in 2008, because the revenue proportion from TIS (Best gross margin in CCS's business) will decline in the latter half of the year, and the cost of raw materials is likely to increase.

Oversea sales grows fast, but contribution is far from enough

After finishing the integration on CITCC, the development capacity of CCS's overseas business has been improved and polished. In 1H09, the overseas revenue has reached 595Mil RMB, growing 120.4% y/y and 54.9% h/h (Annualized growth is 139.9%). Nevertheless, this business just accounts for 3.3% in the gross income of the company.

In the medium term, the contribution from overseas business to CCS is still far from enough. The factors we consider are as follows: in the first place, its proportion in CCS's total revenue is comparatively low, and degree of the scale is inadequate; in the second place, the foreign business mainly focuses on the underdeveloped areas, so the profitability is naturally lower; in the last place, the infrastructure company hardly achieves the goal of global management, for the competition in the local areas is quite fierce and the potential, and the room of development are restricted.

Risks:

Upside risk：

1. CCS increases its M&A which is appreciated by the market.

2. The company increases the dividend payout ratio, due to the coming of mature stage in its lifecycle.

3. Its expanding in overseas market exceeds the expectation.

Downside risk：

1. The drop of revenue from TIS in 2010 exceeds the expectation.

2. The drop of profit margin of the company exceeds the expectation.

Mature stage means perform growth reaching the ceiling

Following the investment weight on middle and down stream in the value chain of this industry, CCS's focus will accordingly be adjusted. With the gradual cut of its main business (TIS) revenue growth, the overall performance growth has reached the peak in 1H09. Meanwhile, maintenance business, BPO in the latter stage as well as overseas business will be the highlight in future.

In an overall, we think the company has entered its mature stage, on which it will continue merging to keep its growth and raise dividend payout ratio to support its valuation. For a company with stable growth like this kind, stable and considerable dividend yield is critical for attracting long term investment. Based on the current price, we estimated 2.89% dividend yield in 2009 and 3.15% in 2010, largely in line with HSI Index (2.78% now). Given its still up yet not strong overall valuation attraction, we rate CCS “Hold”, with 12-Month TP of HK$4.50.

Financial Data Ⅰ

Financial Data Ⅱ

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