3 reasons why Hong Kong wireless telco services is lacklustre

It's more than just slow earnings growth.

According to Barclays, it continues to see little to excite in Hong Kong wireless as things stand.

Here are 3 reasons why:

1) We see revenue momentum as challenged given smartphone penetration at 65-70% levels; 2) a moderately higher competitive environment in 4G means operating leverage into higher margins is likely challenged than not; and 3) we see earnings growth into 2013 slowing significantly. We see yield as an effective backstop to judge entry levels into stocks, and on this basis, we continue to prefer HTHK (EW) to SmarTone (EW).

Revenue momentum is key, and we see this slowing: The first signs of slowing growth came with the 1H12 results; we expect 2H12 data points to accentuate the same trends. Can margins continue to rise as this revenue momentum slows? We doubt it as there is not much leeway in what are anyway lean and well-managed cost structures.

Yield backstop – we prefer HTHK to SmarTone: 1) SmarTone is 100% wireless while HTHK is 40% fixed line with stable cash flows – we like the cushion given unpredictable wireless competitive dynamics – and 2) HTHK's 75% payout leaves room for yield upside – SmarTone is at 100%.

SmarTone – we are trimming earnings; is the 100% payout secure?: Primarily on our slower top-line growth assumptions, we cut our FY06/13 and FY06/14 EPS estimates by 14% and 21%, respectively. A 100% payout estimate still leaves us with a 7.0% yield, suggesting limited downside risk, but with a backdrop of rising capex and falling FCFs, we would want confirmation that this is sustainable before seeing this as a rerating catalyst. Our earnings cuts leave us with a lower 12-month price target of HK$14 (down from HK$16 earlier but still DCF based).

HTHK – need revenue momentum as a positive catalyst but likely elusive: Wireless service revenue growth slowed to 2% y/y in 1H12, and we estimate 0.5% y/y for 2H12. We believe this needs to accelerate to drive higher earnings growth in 2013 and beyond.

Our preference order within the Hong Kong telecom stocks: We like PCCW (OW) as a cheaper entry point into HKT; at these levels, we would prefer HKT (EW) over HTHK (EW) given its higher yield and then SmarTone.