September 11, 2017 / 7:06 AM / 9 months ago

Fitch Upgrades KT Corporation to 'A'; Outlook Stable

(The following statement was released by the rating agency) SEOUL, September 11 (Fitch) Fitch Ratings has upgraded South Korea-based KT Corporation's (KT) Long-Term Foreign- and Local-Currency Issuer Default Ratings (IDRs) and its senior unsecured ratings to 'A' from 'A-'. The Outlook on the IDRs is Stable. The upgrade reflects our expectations of a sustained stronger financial profile achieved through the disposal of non-core assets, workforce reduction and effective cost control. The company has prioritised debt reduction, which will provide a buffer for its financial profile as we expect an increase in 5G investment from 2019. Our view is that KT's management will continue to show financial discipline. KT's ratings also reflect its position as a diversified telecommunications operator in Korea's oligopoly-like market with a leading position in fixed-line voice, broadband and pay-TV services. It is also well-entrenched as the second-largest mobile-service operator. KEY RATING DRIVERS Improvement in Leverage: Fitch expects KT's leverage to stay relatively low with solid operating cash flows and modest capex in the medium term. Gross debt has fallen substantially over the past three years due to proceeds from the sale of its stakes in financial subsidiaries and positive free cash flow. Fitch forecasts gross debt to decrease further in 2017 from KRW8.1 trillion at end-2016 as management continues to prioritise balance-sheet improvement over business expansion. Debt was KRW6.5 trillion at end-2Q17. We forecast its FFO adjusted net leverage ratio to remain around 1.2x in 2017-2018 (2016:1.3x). Capex Increase from 2019: We think KT's probable increase in capex, due mainly to 5G investment, is likely to be manageable within the current rating as long as operating cash flows remain robust. However, there is still a high level of uncertainty over the amount of capex after 2018. We expect KT's management to remain cautious in executing its capex plans and balance its investment with maintaining its financial profile. Regulatory Uncertainty Resolved: The government finalised its plan to lower the burden on households' telecom bills by increasing the discount on monthly tariffs to 25% from the current 20% and expanding benefits to the low-income population by cutting KRW11,000 from their telecom bills. We estimate that the move will lower KT's revenue by KRW150 billion (less than 1% of total revenue) and operating profit by KRW90 billion (around 6%-7% of EBIT), largely in line with the government's guidelines. We expect KT's net leverage ratio to remain low even after the impact of the tariff cut. Solid Profitability: Fitch expects KT's margins to continue to benefit from stable marketing and selling, general and administrative costs following restructuring to streamline its businesses and labour force. Margins are likely to come under some pressure from the government-driven tariff cuts, but KT aims to keep the overall growth in operating expenses lower than revenue growth. Contraction in fixed-line voice service is likely to be offset by solid growth in internet-protocol television (IPTV) and other media businesses. We expect KT's operating EBITDAR margin to stay at above 20% in the medium term (2016: 22%). Growing Broadband and Media: The decline in KT's traditional fixed-line telephony service is more than offset by its growing broadband and media businesses. Broadband revenue is likely to increase as subscribers convert to more expensive high-speed internet services. We expect the number of IPTV subscribers to continue to grow and generate operating profit from 2017, leveraging KT's leading market share in the broadband market (2Q17: 48.8%, among three incumbent telecom operators in Korea). Revenue from pay-per-view television, home shopping and advertising should also rise in tandem with the increasing IPTV market share. Slowing Wireless Revenue Growth: Fitch expects KT's mobile average revenue per user (ARPU) to decline over the long term, which will slow down wireless revenue growth. This is mainly due to the rising popularity of tariff discounts compared with handset subsidies. In addition, long-term evolution (LTE) subscribers already accounted for 86% of the company's total mobile subscribers in 2Q17, which limits the upside for ARPU from conversion to premium plans. ARPU decreased to KRW34,554/month in 2Q17, from KRW35,291/month a year earlier. DERIVATION SUMMARY KT's market position is strong, especially in fixed-line operations where its market share is around 80% (60% including internet phone). However, KT's operating EBITDAR margins are lower than other telecom peers rated 'A' in the APAC region, such as Singapore Telecommunications Limited (A+/Stable), due to relatively higher marketing costs and declining fixed-line telephony services. However, KT's margin has improved substantially since 2015 when the enactment of the Handset Distribution Reform Act reduced competition in the wireless market. Leverage is generally better than other peers; we expect KT's balance sheet to stay healthy with an FFO adjusted net leverage ratio of around 1.2x. KT's operating EBITDAR margin, based on consolidated financials including BC Card Co., Ltd, is lower than that of its core-telecom operations as BC Card generates a high-single digit margin compared with the core-telecom operations' 28% in 2016. KT's core-telecom margins are slightly better than its principal peer, SK Telecom Co., Ltd (SKT, A-/Stable) mainly due to KT's restructuring efforts to reduce its workforce and streamline its operations, while their leverage ratios are similar. However, both SKT and KT enjoy strong market positions as the two largest companies in the oligopolistic Korean telecoms market. While KT has a strong market presence in the fixed-line segment with over 80% market share, SKT is leading the wireless market with around 50% of market share. KEY ASSUMPTIONS Fitch's key assumptions within our rating case for the issuer include: - Revenue to increase by low single-digit percentage in 2017 as growing broadband and media (including IPTV) revenue offsets the decline in fixed-line voice revenue - Operating EBITDAR margin in 2017 to be similar to the 2016 level with effective cost control and moderate increases in marketing costs - Capex to stay around KRW3.2 trillion (cash basis) in 2017 (2016: KRW3.2 trillion) - Dividend payout to increase slightly from KRW800 per share in 2016 - Free cash flow to remain positive in 2017 RATING SENSITIVITIES Future Developments That May, Individually or Collectively, Lead to Negative Rating Action - FFO adjusted net leverage sustained at above 1.5x (2016: 1.3x) - Sustained decline in absolute level of operating EBITDAR - Sustained negative pre-dividend free cash flow Positive rating actions are unlikely in the medium term due to the market environment and our expectations for the company's investment and shareholder returns. LIQUIDITY Robust Liquidity: As of end-June 2017, KT had cash and cash equivalents of KRW1.7 trillion, which was sufficient to cover short-term debt of KRW1.0 billion. KT has ready access to both overseas and local capital markets when in need of external financing. KT held nearly KRW1.7 trillion of unused credit facilities with various financial institutions at end-June 2017. Contact: Primary Analyst Shelley Jang Director +82 2 3278 8370 Fitch Ratings Australia Pty., Korea Branch 9F Kyobo Securities Building 97, Uisadang-daero, Yeoungdeungpo-Gu Seoul, Korea Secondary Analyst Jeong Min Pak Senior Director +82 2 3278 8360 Committee Chairperson Steve Durose Managing Director +61 2 8256 0307 For regulatory purposes in various jurisdictions, the supervisory analyst named above is deemed to be the primary analyst for this issuer; the principal analyst is deemed to be the secondary. 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