Expanding Two Wings And Smart Tower Businesses Will Improve Future Operational Efficiency

Key Takeaways

• Expansion into Two Wings business and Smart Tower growth indicates strategic diversification to drive future revenue beyond core offerings.
  
• Emphasis on technological innovation and resource coordination suggests improved efficiencies, potential earnings growth, and competitive advantage.
  
• Challenges with cash flow, EBITDA maintenance, and capital efficiency could pressure profitability despite rapid growth in emerging business segments overshadowed by high expenses.

Catalysts

Provides telecommunication tower infrastructure services in the People's Republic of China.

• The company is actively expanding its Two Wings business, which has shown a revenue contribution increase to 13.7% and achieved a 22.4% growth in the Smart Tower business. This strategic diversification is expected to boost future revenue growth beyond the core TSP business.
  
• The upgrade of 230,000 telecommunication towers to digital towers, serving multiple industries, could enhance operational efficiency and open new revenue streams, potentially improving net margins and profitability in future periods.
  
• The company's focus on technological innovation, highlighted by a 40% increase in R&D expenses and a 68% rise in the number of branded patents, suggests a strong pipeline of new services and efficiencies that could lead to improved earnings and competitive advantages.
  
• The ongoing emphasis on cost control, resource coordination, and co-location, specifically in the TSP business, positions the company to improve its EBITDA margins and operational efficiency, which can positively impact future net profit growth.
  
• China Tower’s proactive dividend policy, with a full-year dividend payout ratio increase to 76%, reflects strong cash flow and financial health. This may attract more investors and could lead to stock price revaluation if the company continues to maintain strong cash generation and shareholder returns.

China Tower Future Earnings and Revenue Growth

Assumptions

• Analysts are assuming China Tower's revenue will grow by 4.5% annually over the next 3 years.
• Analysts assume that profit margins will increase from 11.1% today to 20.6% in 3 years time.
• Analysts expect earnings to reach CN¥23.2 billion (and earnings per share of CN¥1.32) by about May 2028, up from CN¥11.0 billion today. However, there is a considerable amount of disagreement amongst the analysts with the most bullish expecting CN¥27.7 billion in earnings, and the most bearish expecting CN¥16.1 billion.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 11.0x on those 2028 earnings, down from 16.8x today. This future PE is lower than the current PE for the HK Telecom industry at 13.9x.
• Analysts expect the number of shares outstanding to decline by 0.68% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 6.66%, as per the Simply Wall St company report.

China Tower Future Earnings Per Share Growth

Risks

• The decrease in the number of newly built 5G base stations in 2024 compared to 2023, coupled with an increase in CapEx, raises concerns regarding capital efficiency and future capital expenditures, potentially impacting the company's profitability and cash flow.
  
• The growth rate in the traditional tower business was below 1%, which could be a result of decreased capital investment in 5G infrastructure by TSPs, limiting future revenue growth.
  
• The rise in accounts receivables, especially from the Three Major TSPs, indicates potential cash flow issues and could affect net margins and overall financial health if collection challenges persist.
  
• Although the Smart Tower and Energy businesses grew rapidly, the high R&D and operational expenditures required to drive this growth could outweigh the income benefits in the short to medium term, pressuring net earnings.
  
• Staff costs and the overall increase in operating expenses may pose a challenge to maintaining EBITDA and EBITDA margin improvements, impacting overall profitability.

Valuation

• The analysts have a consensus price target of HK$13.165 for China Tower based on their expectations of its future earnings growth, profit margins and other risk factors. However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of HK$15.86, and the most bearish reporting a price target of just HK$9.27.
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2028, revenues will be CN¥112.4 billion, earnings will come to CN¥23.2 billion, and it would be trading on a PE ratio of 11.0x, assuming you use a discount rate of 6.7%.
• Given the current share price of HK$11.24, the analyst price target of HK$13.17 is 14.6% higher.
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.