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China Communications Services Corporation Limited (0552): Review on 1H07 result

Tuesday, November 6, 2007

9301

China Communications Services Corporation Limited(552)

Recommendation on 6 November 2007
Recommendation	Buy
Price on Recommendation Date	$6.090
Suggested purchase price	$6.090
Target Price	$7.550

Weekly Special - 2333 Great Wall Motor

Doubled net profit attributable to equity shareholders in 1H07

In the 1H07, China Communications Services Corporation Limited (CCS) had an increase in revenues to 7,365 million from 6,372 million, where the year-to-year increment was 15.58%. In addition, its net profit attributable to equity shareholders in the period nearly doubled to 374 million from 194 million.

Nevertheless, the apparent sharp increment of the net profit was indeed due to the loss realized in 1H06 for the deficit on revaluation on property, plant and equipment for a total amount of 105 million incurred during its restructuring in preparation for listing. Thus, if we exclude such effect of deficit on revaluation of assets, the net profit attribution to equity shareholders for 1H07 is about 25% more than for 1H06, which is much less than the one shown in the income statement. But it is still encouraging to see such advance, and we are positive on future development of CCS.

Decline in gross profit margin but increased net profit margin

Although there was a double-digit increment in total revenues for CCS in 1H07, its gross profit only managed to increase to 1,281 million from 1,165 million, compared with the same period in previous year, which raised 9.98% only. Besides, its gross profit margin in 1H07 reduced to 17.39% from 18.28% in 1H06. This was mainly because there was a noticeable increase in subcontracting charges in 1H07, as CCS began demanding its subcontractors for telecommunications infrastructure services to expand their scope of provision of materials, so that CCS is able to better manage its working capital. Thus, we believe that this is not a big concern for CCS, but an operating strategic in order to increase their liquidity.

What’s more, the net profit margin of CCS had a promising enhancement from 3.05% in 1H06 to 5.08% in 1H07. When we exclude the effect of the deficit on valuation mentioned above in 1H06, although the actual net profit margin in 1H06 was approximately 4.70%, CCS still showed that they did actually manage to increase their profitability in 1H07.

Expecting potential expansion after acquisition from parent company

In August 2007, CCS completed the acquisition from its parent company, China Telecommunications Corporation (CTC), for the telecommunications infrastructure services, business process outsourcing services and applications, content and other services located in 13 province, municipality and autonomous regions, together with the equity interests in Guangdong Nanfang Communication GSM Intelligent Card System Co. Ltd., and NingBo Public Information Industry Co. Ltd. from CTC.

Not only had such acquisition brought further expansion opportunities to CCS as it will have more exposure in different provinces in PRC, especially when those businesses are located in middle and western areas where the economic growth are prompt and have great potential, but they would also be expected to be favorable from a larger scale of operations nation-wide. So, we are optimistic in the future development of CCS in the coming years, as well as its potential to improve its profitability due to economic of scale after its expansion.

Benefited from the development of 3G businesses in PRC

Since the revenue from telecommunication infrastructure services accounted for near half of the total revenues for CCS, it is reasonable to expect that the development of 3G businesses in PRC will be favorable to the group, as there should involve numerous businesses opportunities for infrastructure services, especially when the current development of the 3G businesses is only being operated in 10 trial cities. Thus, we believe that the potential for further expansion for the company is still very great.

Management of business risks

Firstly, it was believed that CCS might depend too much on its parent company, CTC, in the past years. However, in 1H07, we saw that the total revenues of CCS from CTC decreased to 45.6% in 1H07 from 51.4% in 1H06, where shows CCS tried to improve its revenue structure in order not to depend too much on only one customer, and we believe it will be able to further improve such revenue structure when participating into more 3G businesses for mobile operators.

What’s more, although CCS currently focused on domestic market only and the extent of its exposure to the oversea market was very limited, the management of CCS did realize such problem and started to cooperate with other telecommunications equipment vendors in various projects for oversea markets, so as to gain opportunities for its development in oversea markets. It may bring extra momentum for the future growth of the company.

Conclusion

To conclude, the growth of CCS in 1H07 is stable and steady, despite not a strong one, we are positive on its future growth, since it showed an improvement in not only its profitability but also their revenue structure. Besides, CCS completed the acquisition from its parent company in August 2007, which enables their businesses covering more areas in PRC. Furthermore, the development of 3G businesses in PRC, as well as starting its participation in oversea markets will both bring more expansion opportunities for the company in the coming years. Therefore, we believe that CCS will be able to keep growing healthy in the coming years. Our rating is “Buy”.

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