China Mobile (NYSE:CHL) upgraded to BUY

Rating BUY (File in pdf fprmat: CV_CHL_2009_Q2.pdf)

We recommend a BUY rating on China Mobile (NYSE:CHL). The growth of CHL in 2008 was slowed down due to Global Financial Crisis. However, compared with other rivals CHL was achieving a relative high profitability in 2008. As CHL is licensed to run 3G service with TD-SCDMA protocol at the start of 2009, it began to construct 3G network facilities across 22 cities in China. Its continuing high profit from 2G service can also supply CHL’s development in 3G market, and help it overcome the existing technical disadvantages regarding TD-SCDMA. The future outcome of CHL is expected to be positive.

Robust Profitability from 2G service

In 2008, CHL’s revenue and net income growth has been strong. The net profit margin increased to 27.4%, demonstrating a healthy profitability. Comparing to China Telecom (CHA) and China Unicom (CHU), China mobile outperformed in many aspects, such as subscriber base and revenue.

New challenges in 3G service, positive out look

The technological problem with TD-SCDMA may shed negative light on the future development of 3G services of China mobile (NYSE:CHL). The shortage of handset in TD-SCDMA can lead to fatal failure in its future competition. However, the huge profit in 2G services is believed to provide strong financial aid to tackle this problem. China Mobile (NYSE:CHL) is putting a lot effort to perfect its services in the new 3G business.

Fair valuation

With projecting with 26% growth rate in 2009, we estimated the net income for CHL to be 141,981.22 million RMB. EPS of 7.09 is outstanding in the industry. We believe that the stock price of CHL is relative fair.

Estimates(Dec)
(RMB millions)	2005	2006	2007	2008	2009E
Net Income	54,504.00	66,026.00	87,062.00	112,793.00	141,981.22
EPS	2.71	3.32	4.35	5.63	7.09
EPS Change (YoY)	18%	23%	31%	29%	26%

China Mobile Limited (NYSE:CHL)

Key Income Statement Data	2005	2006	2007	2008
(RMB, millions)
Total Revenue	249,576	295,358	356,959	412,343
Total Operating Expenses	-171,855	-203,433	-232,891	-269,728
Operating Income	77,721	91,925	124,068	142,615
Net Finance Costs	-1,346	-1,510	-1,825	-1,550
Profit Before Taxation	78,489	96,176	129,238	149,743
Tax Benefit/ (Expense)	-23,945	-30,062	-42,059	-36,789
Profit for the Year	54,544	66,114	87,179	112,954

Key Cash Flow Statement Data	2005	2006	2007	2008
Cash from Operating Activities	131,709	149,346	168,612	193,647
Cash from Investing Activities	-87,116	-118,841	-123,039	-139,026
Cash from Financing Activities	-25,173	-23,587	-37,276	-45,684
Net Change in Cash	19,312.00	6,706.00	7,692	8,567

Key Balance Sheet Data	2005	2006	2007	2008
Cash & Equivalents	64,461	71,167	78,859	87,426
Total Current Assets	123,736	171,507	207,635	240,170
Property/Plant/Equipment, Total - Net	252,563	270,710	304,590	363,265
Total Assets	385,618	494,676	563,493	657,697
Total Current Liabilities	109,954	140,607	154,953	180,573
Long Term Debt	12,912	9,941	9,949	9,920
Total Liabilities	148,366	175,674	189,742	215,419
Total Equity	237,252	319,002	373,751	442,278
Total Liabilities & Shareholders' Equity	385,618	494,676	563,493	657,697

Market Comparisons	Company	Industry	Sector	S&P 500
P/E Ratio (TTM)	12.4	12.54	9.43	44.24
Beta	0.97	0.48	0.64	1.04
Dividend Yield	3.6	0.17	0.15	2.16
Payout Ratio(TTM)	42.88	42.76	31.21	53.43
Sales (MRQ) vs Qtr. 1 Yr. Ago	13.4	-8.87	-6.07	-8.01
Sales (TTM) vs TTM 1 Yr. Ago	15.52	-4.47	-2.54	0.84
EPS (MRQ) vs Qtr. 1 Yr. Ago	18.18	-53.18	-63.15	-37.84
Current Ratio (MRQ)	1.33	1.55	1.33	1.26
Total Debt to Equity (MRQ)	2.74	18.48	123.58	143.79
Return on Assets (TTM)	18.5	7.36	4.79	5.48
Return on Equity (TTM)	27.64	11.18	8.29	15.25
Gross Margin (TTM)	93.65	61.11	47.97	37.42
Operating Margin (TTM)	34.59	18.33	12.4	--
Pre-Tax Margin (TTM)	36.32	17.03	11.64	11.45
Net Profit Margin (TTM)	27.39	10.29	7.4	8.16

Summary

China Mobile Limited (CHL) provides mobile telecommunications and related services in China and Hong Kong area. It has made the most revenue from the communication market (the largest number of subscribers) in China and has a steady growing rate. The profitability is still strong in terms of 2G service. In the competition with other rivals, China Mobile is ahead in many aspects. Although China Mobile has obtained a 3G license of a less well-established protocol, the outperforming in 2G will give the company enough resource to offset the disadvantage. Thus, China Mobile is expected to have a positive outlook.

Recommendation: Buy

1. Robust profitability from 2G service

In 2008, China Mobile’s revenue increased 15.5% to Rmb412.3 billion with 87.9 million new users. Basic EPS increased from Rmb4.35 in 2007 to Rmb5.63. The steady growth indicates that China Mobile continues attracting new customers due to its stable network facilities and a strong support system, which can guarantee the high standard of services.

Looking at revenue, operating income and net income for China Mobile in the last 2.5 years, it is apparent that total revenue and net income growth has been consistent and strong. The plateau in operating income is attributed to increase in capital expenditure related to 3G network development.

CHL_09q2_1

Resource: www.reuters.com

Comparison with competitors

The strength of CHL Company in terms of revenue, EPS and market occupation is evident in the charts below with the comparison of CHA and CHU. In the past four years, across all the three indexes CHL has experienced a steady growth whilst small increase or decrease occurred for the other companies. Within the time period, CHL has almost doubled the revenue, EPS and subscriber number of those in 2005 and those of its rival companies by the time. In particular, the large amount of 2G service subscribers correlates largely to its success in revenue and EPS. Therefore, it is fair to predict the company will continue to power on in the short period with the support of its massive consumers.

CHL_09q2_2

CHL_09q2_3

Note: The subscriber base of CHA is for local wireline services. For CHU, the subscriber number is only based on GSM services, excluding CDMA.

2. New challenges in 3G market, positive outlook.

In the business of telecommunications, there are only two other competitors of China Mobile in the Market, namely China Unioncom and China Telecom. Particularly in the field of mobile phone communication, it was only until 2008 that China Telecom has started the service and entered the market. With the support of the government, China Telecom has become the newest rival together with the China Unioncom to upset the monopolistic operation of China Mobile in the market. The competition among the three companies has become increasingly severe under the recent government licensing of the 3G services. In fact, China Mobile is deemed to be disadvantaged on the offset, as the 3G technology the company has obtained is less well-established and can only be used within China. However, it has launched a series of research programs, as well as commercial campaign in order to make up its technological weakness in comparison with its two rivals.

Looking for suppliers of the new network protocol handset is a critical issue for CHL to survive. The company now is working on offering more choices of the handset models which can support the function of GSM and TD-SCDMA. At the moment, although 4 out of the 5 terminal mobile phone production companies, namely Nokia, Motorola, Samsung, and LG have long-term agreement with CHL in phone supplies, the variety of the models is limited. The cooperation with a Chinese handset company, Lenovo however is the most recent solution to the shortage the company has carried out. At the end of this month, the launch of the OPhone is expected to exclusively support all the services provided by CHL. The design of the OPhone with all the trendy characteristics, such as touch screen is also aimed to meet the need of its potential young customers.

Despite the relatively disadvantaged offset in the development, it is hard to predict the future position of CHL in the 3G market in the long-run. The current technological success of the rival companies does not contribute to their overall revenue which is much less than that of CHL. For CHL the development of 3G services is not and will not be as vital as 2G in the near future. This is because comparing to 3G services its strong standing in its 2G services generates more revenue against the same cost. Before the time when the 3G market becomes dominant in a few years time, the revenue CHL generates through the 2G services, will make it finically better off in the long-run investment of 3G service development.

Comparing China Mobile to China Telecom (NYSE:CHA) and China Unicom Ltd.(NYSE:CHU) in financial strength, profitability and management effectiveness, the advantage of CHL becomes more evident.

CHL_09q2_4

In terms of financial performance, the graph comparing the Current Ratio and Total Debt to Equity between the three companies demonstrates a relatively low debt service for CHL. The Current Ratio of China Mobile is almost 4 times as much as that of the other competitors, and the Total Debt to Equity, nearly 1/28 to that of CHA and 1/3 to that of CHU. In addition, from the profitability graph it can be concluded that CHL has a better position than the other two with its outstanding figures in various margin indexes. Alongside high ROA and ROE gives CHL more advantage, as they make the shares of CHL more appealing to investors.

Therefore, based on the ratios analysis, CHL is obviously ahead of its competitors in many aspects. Its advantages in financial strength and profitability allow the company to increase capital expenditure, a large proportion of which will be invested in the 2G/3G integration and 3G construction. The great amount of investment will help CHL to offset the demerits of the TD-SCDMA technology. Taking advantage of strong performance in 2G services, CHL can make fast inroads into the 3G market.

DuPont Analysis

		2005A	2006A	2007A	2008A
1	Net margin (NI/Sales)	21.8%	22.4%	24.4%	27.4%
2	Asset turnover (Sales/ Assets)	0.65	0.60	0.63	0.63
3	ROA (1*2)	14.1%	13.3%	15.5%	17.1%
4	Leverage (Assets/ Equity)	1.63	1.55	1.51	1.49
5	ROE (3*4)	23.0%	20.7%	23.3%	25.5%

· Net margin has grown stably during the last four years. It can be attributable to the increase of subscribers from 246.7 million to 457.3 million. Since China Mobile has got 3G license at begin of 2009, the capital expenditure related to 3G network will increase dramatically. Therefore we expect that the growth of net margin will slow down.

· Asset turnover stayed fairly stable in the past. It is believed that China Mobile will still keep the relative high management effectiveness in the near future.

· Leverage stayed in a low level in the last four years, indicating a relative low debt service for China Mobile. As retain earning accumulated faster than debt improved, this ratio decreased slightly.

· As ROE increased to 25.5% in 2008, the valuation of China Mobile is affected positively.

3. Fair valuation

	2006H2	2007H1	2007H2	2008H1	2008H2	2009H1E
Net Income	35758	37907	49155	54849	57944	65608.4
EPS	1.79	1.89	2.45	2.73	2.89	3.27
EPS growth rate		5.63%	29.54%	11.44%	5.59%	13.23%

The net income for the first half year of 2009 is estimated to be 65608.4 million RMB. EPS is estimated to rise to 3.27 in 2009H1, compared to 2.89 in 2008H2.

The EPS growth rate is expected to be 13.23%. As P/E ratio of China Mobile is 13.15, the Price/Earning to Growth Ratio is 0.99, which suggests that CHL’s stock is fairly priced. Since CHL has a positive outlook in the 3G market, we recommend a buy rating.

China Mobile Limited - Annual Income Statement, 2005-2008 (RMB, Millions)


Year to December	2005A	2006A	2007A	2008A
Revenue	181,772.00	280,648.00	338,953.00	392,429.00
Other Revenue, Total	67,804.00	14,710.00	18,006.00	19,914.00
Total Revenue	249,576.00	295,358.00	356,959.00	412,343.00
Cost of Revenue, Total	28,555.00	21,234.00	23,830.00	24,905.00
Gross Profit	153,217.00	259,414.00	315,123.00	367,524.00
Selling/General/Admin. Expenses, Total	87,878.00	83,107.00	96,250.00	116,992.00
Depreciation/Amortization	55,422.00	64,777.00	67,612.00	71,713.00
Unusual Expense (Income)	--	2,910.00	2,781.00	3,248.00
Other Operating Expenses, Total	--	31,405.00	42,418.00	52,870.00
Total Operating Expense	171,855.00	203,433.00	232,891.00	269,728.00
Operating Income	77,721.00	91,925.00	124,068.00	142,615.00
Interest Expense, Net Non-Operating	-1,346.00	-1,510.00	-1,825.00	-1,550.00
Interest/Invest Income - Non-Operating	1,615.00	2,431.00	4,024.00	5,985.00
Other, Net	499	3,330.00	2,971.00	2,693.00
Net Income Before Taxes	78,489.00	96,176.00	129,238.00	149,743.00
Provision for Income Taxes	23,945.00	30,062.00	42,059.00	36,789.00
Net Income After Taxes	54,544.00	66,114.00	87,179.00	112,954.00
Minority Interest	-40	-88	-117	-161
Net Income	54,504.00	66,026.00	87,062.00	112,793.00
Basic Normalized EPS	2.761	3.42	4.446	5.75
Diluted Normalized EPS	2.747	3.388	4.373	5.661

China Mobile Limited – Balance Sheet, 2005-2008 (RMB, Millions)

Year to December	2005A	2006A	2007A	2008A
Cash			70,500.00	84,434.00
Cash & Equivalents	64,461.00	71,167.00	8,359.00	2,992.00
Short Term Investments	41,925.00	82,294.00	109,685.00	130,833.00
Cash and Short Term Investments	106,386.00	153,461.00	188,544.00	218,259.00
Accounts Receivable - Trade, Net	6,579.00	7,458.00	7,063.00	7,022.00
Receivables - Other	2,163.00	2,968.00	3,053.00	3,754.00
Total Receivables, Net	8,742.00	10,426.00	10,116.00	10,776.00
Total Inventory	2,365.00	3,007.00	3,295.00	3,494.00
Prepaid Expenses	3,583.00	4,613.00	5,680.00	7,641.00
Other Current Assets, Total	2,660.00	--	--	--
Total Current Assets	123,736.00	171,507.00	207,635.00	240,170.00
Property/Plant/Equipment, Total - Gross	458,314.00	463,630.00	549,077.00	666,058.00
Accumulated Depreciation, Total	-205,751.00	-192,920.00	-244,487.00	-302,793.00
Property/Plant/Equipment, Total - Net	252,563.00	270,710.00	304,590.00	363,265.00
Goodwill, Net	0	36,894.00	36,894.00	36,894.00
Intangibles, Net		700	469	298
Long Term Investments	77	77	77	84
Other Long Term Assets, Total	9,242.00	14,788.00	13,828.00	16,986.00
Total Assets	385,618.00	494,676.00	563,493.00	657,697.00
Accounts Payable	42,445.00	57,555.00	64,149.00	79,730.00
Accrued Expenses	39,858.00	10,912.00	10,454.00	15,432.00
Notes Payable/Short Term Debt	1,359.00	5,208.00	1,853.00	2,111.00
Current Port. of LT Debt/Capital Leases	68	68	68	68
Other Current liabilities, Total	26,224.00	66,864.00	78,429.00	83,232.00
Total Current Liabilities	109,954.00	140,607.00	154,953.00	180,573.00
Long Term Debt	12,912.00	9,941.00	9,949.00	9,920.00
Total Long Term Debt	12,912.00	9,941.00	9,949.00	9,920.00
Total Debt	14,339.00	15,217.00	11,870.00	12,099.00
Deferred Income Tax	146	192	122	80
Minority Interest	283	371	488	629
Other Liabilities, Total	25,071.00	24,563.00	24,230.00	24,217.00
Total Liabilities	148,366.00	175,674.00	189,742.00	215,419.00
Common Stock, Total		2,130.00	2,136.00	2,138.00
Additional Paid-In Capital		383,807.00	385,743.00	386,237.00
Retained Earnings (Accumulated Deficit)		-66,935.00	-14,128.00	53,903.00
Total Equity	237,252.00	319,002.00	373,751.00	442,278.00
Total Liabilities & Shareholders' Equity	385,618.00	494,676.00	563,493.00	657,697.00

China Mobile Limited – Cash Flow Statement, 2005-2008 (RMB, Millions)


Year to December	2005A	2006A	2007A	2008A
Net Income/Starting Line	78,264.00	96,176.00	129,238.00	149,743.00
Depreciation/Depletion	56,368.00	64,574.00	67,354.00	71,509.00
Amortization	0.00	203.00	258.00	204.00
Non-Cash Items	10,534.00	8,274.00	5,578.00	3,693.00
Changes in Working Capital	-13,457.00	-19,881.00	-33,816.00	-31,502.00
Cash from Operating Activities	131,709.00	149,346.00	168,612.00	193,647.00
Capital Expenditures	-66,027.00	-77,014.00	-98,551.00	-120,853.00
Other Investing Cash Flow Items, Total	-21,089.00	-41,827.00	-24,488.00	-18,173.00
Cash from Investing Activities	-87,116.00	-118,841.00	-123,039.00	-139,026.00
Financing Cash Flow Items	-7,246.00	-1,414.00	-1,802.00	-1,589.00
Total Cash Dividends Paid	-18,894.00	-26,162.00	-34,088.00	-44,560.00
Issuance (Retirement) of Stock, Net	3,422.00	4,093.00	1,614.00	465.00
Issuance (Retirement) of Debt, Net	-2,455.00	-104.00	-3,000.00	0.00
Cash from Financing Activities	-25,173.00	-23,587.00	-37,276.00	-45,684.00
Foreign Exchange Effects	-108	-212	-605	-370
Net Change in Cash	19,312.00	6,706.00	7,692.00	8,567.00

Analyst Certification

I, Junqiang Zhang, hereby certify that the views expressed in this research report accurately reflect my personal views about the subject securities and issuers. I also certify that no part of my compensation was, is, or will be, directly or indirectly, related to the specific recommendations or view expressed in this research report.

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China Mobile (NYSE:CHL) upgraded to BUY