Chunghwa Telecom

Moat: 3/5

Understandability: 2/5

Balance Sheet Health: 4/5

Chunghwa Telecom, a Taiwanese telecommunications giant, holds a significant position in Taiwan’s fixed-line, mobile, and internet service market. However, a changing competitive landscape and regulatory hurdles present challenges to its moat and resilience.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Business Overview and Analysis: Chunghwa Telecom (CHT) is a leading integrated telecommunications provider in Taiwan with a wide range of services. It is also partly owned by the government (though it’s not a state-owned enterprise).

CHT’s revenues come from several segments with Mobile and Consumer Business being the top two contributors. In 2022, mobile services generated 33% of revenues while consumer business contributed 30%. Then other areas were Enterprise Business (22%), Domestic Fixed Communications (12%), and International Fixed Communication & Others (3%).

Mobile Communication: This segment offers mobile voice and data services and mobile devices. In recent times, there’s been a marked increase in mobile service revenues, primarily due to 5G adoption.
Consumer Business: CHT provides broadband and digital content services to individual customers. This segment is relatively stable. The increased demand for higher-speed broadband and online services are key trends in this sector.
Enterprise Business: This segment provides tailored IT, data, and communication solutions to enterprises. The need for digital transformation by enterprises leads to high growth for the segment.
Domestic Fixed Communications: This segment includes local and long-distance voice telephony, internet access, and traditional services. The decline in landline use is a major challenge to the domestic segment.
International Fixed Communication & Others: This segment generates revenue from international calling services and revenues from subsidiaries.

Industry and Competitive Landscape: The telecommunication industry is constantly evolving. CHT faces the risk of new entrants, competition from existing players, and rapid technological advancements. In Taiwan’s mobile sector, other major players like Taiwan Mobile, Far EasTone, and Taiwan Star compete with CHT.

The local telecoms sector has seen many new entrants and intense competition. To meet it, CHT’s business model has focused on premium service and quality network to increase customer stickiness. The new entrants rely on lower prices. This is a classic battle for market share between quality and price. The industry also features various regulations and policy changes that can impact operating environment. Government subsidies for investment in technological improvements such as 5G are key incentives provided by the Taiwanese government.

CHT is also trying to leverage their 5G network to build services that connect customers and businesses with new technology. They want to explore AI, Metaverse, and Blockchain technology as future growth areas.

Financials In-Depth:

CHT has demonstrated an impressive balance sheet in the latest 2022 filings with a good cash reserve and a strong asset base. While this is a positive sign, it should be noted that a significant proportion of their assets are listed as intangible, mainly the huge mobile broadband concessions that is worth NT$ 121 billion. Therefore a proper analysis of their operations is needed as the company’s financial well being is primarily dependent on operating activities rather than its assets. The recent financial results for year ended in December 2022 show a solid business.

Revenues increased 3.3% to NT$121.5 billion year-over-year. Mobile revenues grew by 5.7% while overall consumer business grew by 5.1%, offset by a 4.6% decline in domestic fixed-line communications revenues.
Operating profit increased 2.4% year-over-year to NT$33.8 billion, while net income attributable to shareholders increased 3.4% year-over-year to NT$27 billion.
The company continues to focus on debt reduction as the current ratio has increased from 1.28 to 1.33 year-over-year. Free cash flows were NT$36 billion, an increase of 5.3% year-over-year.
Overall, operating profitability has decreased slightly due to a mix of cost pressures and some changes in how revenue is allocated. There are large and unpredictable fluctuations in non-operating income/losses (both at the consolidated level and at the subsidiary level). CHT needs to improve profitability in core businesses as these non-operating items distort the true financial position of the company.
CHT maintains a strong focus on network investment, especially in 5G and fiber broadband, as these are considered key drivers of future growth.

While the company’s financials present a healthy picture, it’s crucial to recognize that the telecommunication sector faces constant changes in technology, as well as more competitors. This means that the company needs to continually invest in capital expenditures to maintain its market position.

Moat Analysis: CHT possesses a moderate economic moat, primarily derived from its established network infrastructure and its position as an incumbent telecommunications service provider in Taiwan. However, this moat is not impenetrable. The barriers to entry for mobile and broadband businesses are not as high as for other industries. The main sources of CHT’s moat are:

Scale of Operations: CHT benefits from economies of scale due to its large existing customer base.
Network Infrastructure: Its extensive infrastructure, including fixed-line and mobile networks, is costly to replicate and can be viewed as a competitive advantage. However, the increasing access to shared network infrastructure might reduce this advantage.
Customer Lock-in: Switching costs for telecom services are moderate. However, the company benefits from strong loyalty through bundled offerings and premium services.
Barriers to Entry: The need for large investment in communication infrastructure creates a barrier of entry to new firms, hence established players like CHT have an advantage, but this is not absolute.

Moat Rating: 3/5 CHT has a moderate moat, as described above. Its infrastructure and market position are significant competitive advantages. However, high competition and the evolving technological landscape mean the moat is vulnerable to external factors.

Legitimate Risks to the Moat and Business:

Competition: Competitors may attract existing subscribers with aggressive pricing or new and innovative technologies.
Technological Disruption: Rapid advancement in technologies could make current infrastructure obsolete.
Regulatory Changes: Changes in government regulations and licensing can affect operations. A more stringent regulatory environment may increase costs and limit expansion.
Macroeconomic Factors: Economic downturns may reduce demand for services and affect its performance.
Cyber Security: With more and more focus on digitalization and network security, a potential major cyber attack is a potential major disruptor and cause loss of consumer confidence.
International expansion risk: Even though the company plans to grow its international services, the lack of experience in foreign markets could harm its revenues from these segments.
Inflation and Exchange Rate Risk: While the company operates in Taiwan and therefore its business is not directly affected by the global economic slowdown, it must still be noted that its debt is denominated in USD. The USD appreciated greatly in 2022, leading to higher costs for servicing debt.

Management noted that they will pay back its outstanding USD loans if they find opportunities where they can use that cash more profitably than paying back the debt. It seems that there is also a possibility that the company is preparing to take on more debt in the future in case they see a strong business case.

Business Resilience:

CHT shows resilience in the telecom sector by continuing to adapt and innovate. Despite the above risks, CHT’s strong financial position and loyal customer base provide a buffer for adverse situations.

Understandability: 2 / 5

CHT’s business can be considered moderately complex because of its different service segments and the regulatory factors involved in the business. While an average consumer is familiar with the type of services CHT provides, understanding how all the business units interact and contribute to the company’s profitability, as well as all the intricacies involved in the financial structure, requires much more understanding of the different variables. Moreover, the Taiwanese regulation adds a layer of complication which might be hard to grasp for many people.

Balance Sheet Health: 4/5

The company’s balance sheet is overall quite healthy:

Strong current ratio, meaning it’s a company that can pay off its debts in the short term.
Low levels of debt.
Good cash reserves. However, the company relies a lot on intangible assets rather than tangible assets for value. Intangibles are hard to evaluate and difficult to liquidate, and they should be taken into consideration when evaluating the health of the balance sheet. The company’s management also mentions that it is willing to buy new assets/other companies to further improve its operations. This can further influence the balance sheet in the future, and should be monitored.

Recent Concerns and Management Stance: While CHT has shown steady growth in revenues, it is evident that competition is a growing threat. The company plans on leveraging its infrastructure to create new services to try and protect its moat. Management is currently very focused on improving profitability and exploring new ventures such as 5G, Cloud Services, AI, and cybersecurity. There are some concerns in the earning calls about a possible decline in cash flows. That should be monitored in the coming years.

CHT is trying to improve its environmental and social footprint by implementing various ESG initiatives. They have been quite active in creating digital inclusion within the local population.