1H22 results in line with market expectation
　　China Telecom (CT) announced its 1H22 results: Revenue grew 10.5% YoY to Rmb242.3bn and net profit attributable to shareholders increased 3.1% YoY to Rmb18.3bn. Excluding one-off gains (excl. taxes) from selling a subsidiary in 2021, we estimate the firm’s attributable net profit grew 12.0% YoY in 1H22. In 2Q22, revenue rose 9.2% YoY to Rmb122.7bn but attributable net profit dropped 2.1% YoY to Rmb11.1bn. Excluding the impact of the one-off gains in 2021, we estimate attributable net profit rose 12.0% YoY in 2Q22. Results are in line with market expectation.
　　Trends to watch
　　Revenue from mobile service and fixed-line broadband businesses grew steadily. In 1H22, revenue from CT’s mobile services grew 6.0% YoY to Rmb99.0bn and the cumulative average revenue per user (ARPU) of the segment edged up 0.7% YoY to Rmb46. We expect the ARPU of the mobile business to maintain low-single-digit growth, driven by the development of sectors using 5G technology (e.g., encrypted calls, cloud storage, and cloud games). In 1H22, revenue from fixed-line and smart family services rose 4.4% to Rmb59.9bn. Overall ARPU of wired broadband edged up 0.9% YoY to Rmb47.2, benefiting from a higher penetration rate of gigaband. We think fixed-line and smart family service revenue will likely maintain stable growth in the future.
　　Industrial digitalization business maintained fast growth. In 1H22, revenue from this segment rose 19.0% YoY to Rmb58.9bn, with that from e Cloud (a cloud computing brand of China Telecom) up 101% YoY to Rmb28.1bn. We expect the firm to diversify its cloud-based solutions and improve operating leverage, utilizing its cloud network resources. We expect revenue from e Cloud to double in 2022. The firm’s internet data center (IDC) business registered YoY growth of 11.1% and reached Rmb17.9bn in 1H22. Revenue from security services grew 43.2% YoY to Rmb5.01bn. In terms of 5G-related business targeting corporate clients, the firm secured more than 1,300 projects of customized networks in 1H22. Revenue from newly-signed projects rose more than 80% YoY, with the gross margin at about 20-30%. We expect profit margin of CT’s 5G projects signed with corporate clients to increase as the firm improves its R&D capability.
　　Stepped up R&D efforts to enhance competitiveness in technologies; increased shareholder returns by distributing stock dividend in 1H22. CT’s R&D expenses rose 41.5% YoY in 1H22. Its capex grew 54% YoY to Rmb41.7bn in 1H22, accounting for 45% of its full-year capex quota (vs. 31% in 1H21). The firm’s capex grew rapidly, which we attribute to the low base in 1H21 when investment slowed due to COVID-19 resurgence. As for the structure of capex, capex related to 4G and 5G decreased 2.5ppt, while industrial digitalization related capex rose 9.3ppt. We believe CT will continue to build industrial digitalization infrastructure, increase its business coverage, and develop services integrating cloud and network. In addition, the firm honored its promise and distributed an interim dividend of HK$0.14/sh in 1H22, with a dividend payout ratio of 60%.
　　Financials and valuation
　　We keep our 2022 and 2023 earnings forecasts unchanged. For the H-shares, we maintain an OUTPERFORM rating. Based on the SOTP valuation method, we calculate H-share market cap at HK$336.7bn and TP at HK$3.68, offering 26.9% upside. For A-shares, we maintain an OUTPERFORM rating. Considering downward average sector valuation of the firm’s IDC business, we assign the IDC sector a lower comparable EV/EBITDA multiple based on the SOTP valuation method. We cut our SOTP-based target price by 20.3% to Rmb5 (offering 32.6% upside) and calculate the A-share market cap at Rmb458.1bn. Stock prices of H-shares and A-shares imply dividend yields of 8.5% and 5.6% for 2022.
　　Risks
　　Intensifying competition; disappointing business transformation and expansion.