KT Corporation: Too Early To Turn Bullish (NYSE:KT)

Elevator Pitch

I maintain my Neutral rating on Korean telecommunications service provider KT Corporation (KT) (OTC:KTCNF) [030200:KS].

This is an update of my prior article on KT Corporation published on June 2, 2020. KT Corporation’s share price has declined by -4% from KRW24,850 as of June 1, 2020 to KRW23,900 as of August 24, 2020 since my last update. KT Corporation trades at 2.9 times consensus forward FY 2020 EV/EBITDA and 0.42 times P/B, and it offers a consensus forward FY 2020 dividend yield of 4.7%.

All eyes are on the possibility of KT Corporation committing to a progressive dividend policy, and the company has notably either maintained or increased its dividends for four consecutive years. But there have been no further updates on KT Corporation’s dividend policy at the company’s recent 2Q 2020 earnings call in early August.

Corporate restructuring initiatives such as the potential spin-off or divestment of its property assets could act as a positive re-rating catalyst for KT Corporation in the future. However, KT Corporation has yet to commit to any concrete corporate restructuring plans yet.

In other words, it is too early to turn Bullish on KT Corporation, as there is no guarantee that KT Corporation will commit to a progressive dividend policy and implement new corporate restructuring initiatives that are value-accretive for shareholders. As such, I maintain a Neutral rating on KT Corporation.

Readers have the option of trading in KT Corporation shares listed either on the New York Stock Exchange with the ticker KT, or on the Korea Exchange with the ticker 030200:KS. For KT Corporation shares listed as ADRs on the New York Stock Exchange, average daily trading value for the past three months is decent at approximately $7 million, but it is relatively lower compared to shares listed in Korea.

For KT Corporation shares listed in Korea, there are limited risks associated with buying or selling the shares in terms of trade execution, given that the Korea Exchange is one of the major stock exchanges that is internationally recognized and there is sufficient trading liquidity. Average daily trading value for the past three months exceeds $20 million and market capitalization is above $4.9 billion, which is comparable to the majority of stocks traded on the US stock exchanges. Institutional investors who own KT Corporation shares listed in Korea include T. Rowe Price Associates, APG Asset Management, Wellington Management Company, and Kopernik Global Investors, among others. Investors can invest in key Asian stock markets either using U.S. brokers with international coverage such as Interactive Brokers or Fidelity, or international brokers with Asian coverage like Hong Kong’s Monex Boom Securities and Singapore’s OCBC Securities.

All Eyes On Potential Changes To Dividend Policy

In my earlier article on KT Corporation published on June 2, 2020, I noted that a renewed focus on profitability under the charge of new CEO Koo Hyun-mo and a new dividend policy could potentially be positive re-rating catalysts for the stock.

There have been no further updates on KT Corporation’s dividend policy in the past three months. Earlier, KT Corporation highlighted at its 1Q 2020 results briefing on May 13, 2020 that “we need to actually come up with a dividend policy that is more predictable for the market.” This seems to suggest that KT Corporation could possibly commit to a progressive dividend policy.

Notably, KT Corporation has either maintained or increased its annual dividends on an absolute basis for four consecutive years between FY 2015 and FY 2019, with dividends per share more than doubling from KRW500 to KRW1,100 over the same period.

Corporate Restructuring To Potentially Help Realize The Value Of Non-Telecommunications Businesses

KT Corporation did provide an update on the company’s plans to improve its profitability at the 2Q 2020 earnings call on August 7, 2020, and it alluded to the fact that the CEO has spoken “about the restructuring of our group companies” at its Corporate Day in May 2020. The company emphasized at the recent quarterly results briefing that “we will be quite bold in restructuring our affiliates and subsidiaries that do not add to our growth or that do not create synergies” and added that “the actual implementation and the speed (of such corporate restructuring initiatives) is going to be quite fast” once the company has decided on any such plans.

Notably, KT Corporation’s key non-telecommunications business, specifically financial services and real estate, did not perform well in 2Q 2020. BC Card, KT Corporation’s payment services business, saw a -1.5% YoY decline in revenue from KRW880.6 billion in 2Q 2019 to KRW867.1 billion in 2Q 2020, due to a decline in credit card usage as a result of reduced consumer spending in general. Revenue for KT Estate, the company’s real estate business, decreased by -7.9% YoY from KRW113.4 billion in 2Q 2019 to KRW104.4 billion in 2Q 2020, as its hotels segment was negatively impacted by international travel restrictions imposed due to COVID-19. Nevertheless, KT Corporation has guided at the company’s recent 2Q 2020 earnings call that it will try to at least maintain flat YoY growth in operating profit for BC Card and KT Estate on a full-year basis in FY 2020.

It is noteworthy that KT Corporation’s real estate portfolio is estimated to be worth at least between KRW4.2 trillion and KRW4.3 trillion, based on fund manager Bonhoeffer Capital’s comments in an October 2018 interview, and a NH Investment & Securities sell-side analyst report (not publicly available) published on KT Corporation on October 21, 2019. The estimated valuation of KT Corporation’s real estate portfolio seems rather conservative, considering that its real estate business generates a normalized operating profit of KRW750 billion every year, based on company estimates that Morningstar has quoted in its research on KT Corporation (access to research available only to subscribers). This also implies that the value of KT Corporation’s real estate portfolio alone accounts for close to two-thirds of the stock’s current market capitalization at around KRW5.8 trillion.

KT Estate, KT Corporation’s real estate business, seems to have limited synergies with the company’s core telecommunications services business. If and when KT Corporation either spins off or divest the company’s real estate assets, it could help to re-rate the stock’s valuations in a positive manner.

Positive On Improved Cost Control That Led To Operating Profit Growth

KT Corporation’s operating profit increased by +18.6% YoY from KRW288.2 billion in 2Q 2019 to KRW341.8 billion in 2Q 2020, as a -4.7% YoY decline in operating expenses more than offset a milder -3.6% YoY decrease in the company’s top line.

At the company’s 2Q 2020 earnings call on August 7, 2020, KT Corporation attributed the operating profit growth in 2Q 2020 to a “sustained effort on cost control and efficient spending.” It is noteworthy that The Korea Herald had earlier reported on March 30, 2020 that KT Corporation’s new CEO Koo Hyun-mo had promised shareholders at the company’s annual general meeting this year that he will “improve the company’s profitability of existing businesses.” The company also stressed at its 1Q 2020 results briefing in mid-May 2020 that “profitability enhancements” will be a key part of the new “management direction of our new CEO.”

I am positive on KT Corporation’s improved cost control in 2Q 2020, which led to the company’s +18.6% YoY operating profit growth in the recent quarter. Market consensus expects KT Corporation’s ROE to improve from 4.6% in FY 2019 to 5.0% and 5.7% in FY 2020 and FY 2021, respectively. KT Corporation’s depressed valuations (detailed in the next section of this article) are largely attributable to its relatively low ROE on an absolute basis. A positive re-rating of KT Corporation’s valuations going forward is dependent on the company improving its future profitability and ROE via superior cost control or corporate restructuring initiatives as highlighted earlier.

Valuation

KT Corporation trades at consensus forward FY 2020 and FY 2021 EV/EBITDA multiples of 2.9 times and 2.2 times, respectively based on its share price of KRW23,900 as of August 24, 2020. In comparison, the stock’s five-year and 10-year average consensus forward next twelve months EV/EBITDA multiples were 2.6 times and 3.2 times, respectively. KT Corporation is also valued by the market at consensus forward next twelve months EV/EBIT and P/E multiples of 8.8 times and 8.7 times, respectively.

KT Corporation’s trailing P/B multiple of 0.42 times also represents a significant discount to the stock’s five-year and 10-year mean P/B multiples of 0.60 times and 0.67 times, respectively.

KT Corporation offers consensus forward FY 2020 and FY 2021 dividend yields of 4.7% and 4.8%, respectively.

Risk Factors

The key risk factors for KT Corporation are a longer-than-expected period of time taken to engage in corporate restructuring initiatives that create value for the company, and a failure to increase future dividends.

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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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