Answering the call

Faced with a slowing global economy investors are increasingly turning to Japanese telecom companies for earnings growth, as a new way of selling phones has lessened the need to aggressively subsidize handsets to lure customers.

The sector had languished under a crippling price war between rivals, which had all but eclipsed the sector's reliable earnings and ability to pay handsome dividends.

But as the global economic downturn grinds on, hurting many consumer-facing companies, Japanese telecoms, such as NTT DoCoMo, are enjoying a resurgence.

While consumers may think twice about buying a car, they will still make phone calls.

Furthermore, unlike traditional defensive stocks, such as food, telecom company earnings are not directly affected by soaring fuel and raw materials costs.

"The market is eyeing telecom firms now that the risk is mounting for downward earnings revisions for industries in general," Franklin Templeton Investments senior portfolio manager Tetsuro Miyachi says. "Telecoms earnings are relatively safe."

Japan's top three wireless operators, NTT DoCoMo, KDDI Corp and Softbank Corp, have boosted their earnings by changing the way they sell phones.

Instead of engaging in a war of attrition by subsidising expensive phones to lure customers from rivals, companies are now raising the prices of handsets, offering instalment plans to pay them off, while at the same time lowering call tariffs.

"The introduction of instalment payment plans seems to have helped settle down a brutal price war, and that has helped to make telecoms popular," Nikko Citigroup analyst Hiroshi Yamashina says.

The sector's underperformance has also left valuations looking attractive compared with international rivals.

Shares of DoCoMo have gained more than 10 percent since April but it still trades at 13 times forecast earnings. The stock underperformed the overall market with a 31 percent fall last year.

KDDI has a price-to-earnings ratio of 10 while DoCoMo's fixed-line parent Nippon Telegraph and Telephone Corptrades on a multiple of 13. KDDI, NTT and Softbank also fell more than the Nikkei average last year.

Softbank trades on the sector's most expensive multiple of 24 times forecast earnings, but is still cheaper than Sprint Nextel's 53 times forecast earnings.

Others are cheaper than China Unicom and BCE Inc's 18 times earnings and Canada's Rogers Communications' 17 times earnings.

"Telecom companies in developing markets had been the investors' choice but with the world's economy slowing down, they have started to focus more on stability, and they see relatively cheap Japanese telecom shares as appealing," Yamashina says.

Business model change

Many market participants chose DoCoMo as the best pick in the sector for its leading position in the industry, healthy balance sheet, and stable dividends. The company has a dividend yield of 2.9 percent, against an average of 1.9 percent for companies listed on the Tokyo Stock Exchange's main board.

Softbank, which entered Japan's $70 billion mobile market in 2006 by buying Vodafone's struggling Japanese unit, pioneered the shift to the new business model later that same year.

Since then, low monthly calling fees have helped Softbank to add more net subscribers than its bigger rivals in each of the past 16 months, prompting rivals to take up the new marketing model and follow with cheaper call charges.

DoCoMo changed to the new scheme in November 2007 and began to see the boost on earnings in the April-June first quarter, when its profits jumped 45 percent on lower handset subsidies.

KDDI, which only adopted the new strategy this June, should see an earnings pickup this quarter.

Analysts say the boost will be lasting. Lower subsidies are good for profits in the long run, as is the ability to squeeze more out of each user locked into longer contracts.

"I think it really improves the finances for the operators, but the operators at the same time are also taking other actions," says Gerhard Fasol, president of consultant firm Eurotechnology Japan.

Operators are also looking at ways to cut the relatively high development costs associated with producing the more complex, feature-rich phones sold in Japan.

DoCoMo plans to provide developers with common software specifications that will allow them to streamline the development process.

But some analysts are unconvinced that Japanese telecoms can deliver long-term value. About 85 percent of Japan's population already has a mobile phone, and operators have not had much success expanding overseas.

"The telecom sector is not attractive to me considering its growth potential," Chibagin Asset Management senior analyst Saburo Hyodo says.

"Carriers are just scrambling for a share in a pie, which is now expanding little. Earnings contribution from overseas expansion is questionable too."

Agencies

(China Daily 09/15/2008 page11)