In the past, KDDI investors could celebrate huge returns, as the stock price more than tripled from 2012 to 2015. Unfortunately, the party did not last long. Despite rising profits and dividends, the stock price has traded sideways since its great appreciation leading up to 2015. The stock currently trades at the same price it did 5 years ago which means that anyone who bought into KDDI at that time received an underwhelming return for several years. In this stock analysis, we will dive deeper into KDDI and tell you why the stock underperformed and whether it is a good investment.
KDDI is a Japanese telecommunications company with revenues of 5.2 trillion yen, the equivalent of around 48 billion US dollars. The company is active in both B2C (business to consumer) and B2B (business to business), with the majority of its revenues being generated from private consumers. KDDI offers mobile cellular and ISP network services to its customers. In addition to that, data centers and corporate networks are offered to business customers.
|74.0 billion $
|0.93 of max. 1.0
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The Japanese mobile communications market is an oligopolistic market. Only 3 companies share almost 185 million mobile communications contracts among themselves. KDDI has a market share of 31.7 percent and thereby loses to the market leader NTT Docomo, which is no longer listed on the stock exchange since the end of 2020. Softbank places third with a market share of 25 percent.
The number of mobile communications subscriptions in Japan has grown steadily in recent years, from 157 million subscriptions in 2016 to 185 million in 2020. KDDI expects further growth in the coming years (page 46), driven by increased smartphone adoption, more business use of smartphones, and the trend that some individuals own more than one device.
KDDI began rolling out its 5G network in March of 2020 and intends to continue this expansion. By 2023, the 5G network is supposed to cover an area as large as the current 4G network (page 46). Customers can already purchase new data plans. These 5G plans are priced higher than comparable 4G plans (page 54). Even though the 5G rollout will cost a lot of money, the additional revenues through higher pricing should justify the costs. I also suspect that the 5G technology will encourage some customers to switch to new, and possibly more expensive, 5G-capable devices. Since KDDI also offers combo deals (smartphone + data plan), this should have a positive impact on revenues. In addition, I think it is possible that some customers without a preference between 4G and 5G will still switch to 5G if their device supports this technology.
Anyone who has ever been to Japan knows that cash is still the predominant payment method there. In the past, most stores exclusively accepted cash, to the frustration of many tourists. This situation is slowly changing, and cashless payment methods are starting to gain traction in Japan. From 2008 to 2018, the share of cashless transactions has more than doubled. Almost a quarter of all private consumer spending is now done without cash. The Japanese government is aiming for 40 percent by 2025 (page 47).
KDDI responded to this trend by launching its own service payment service which lets customers use their smartphones for transactions in 2019. This service already had 23.5 million users and 1.9 million partnering stores by the end of the 2020 fiscal year (page 47). This move makes sense strategically and I assume it will increase customer loyalty and customer retention. Building such ecosystems has already worked very well for other companies (Apple). I assume that customers who use a lot of services of one company are more likely to adopt a new service of the same ecosystem. This is especially important for homogenous products like mobile communications contracts. Without customer loyalty, a company will quickly lose customers to the competition.
KDDI has been growing at an impressive pace, considering that the telecom sector is not known to have high growth rates. Over the past 10 years, earnings per share have increased by close to 12 percent annually. In recent years, growth has slowed down a bit, but remains at a satisfactory level of 8 percent (over the past 5 years). The management of KDDI aims to increase earnings per share by 50 percent from 2019 to 2025 (page 18), which corresponds to an annual growth rate of 7 percent over that period.
Those increases in profit in addition to a slightly raised payout ratio have led to quite generous dividend hikes. Over the last 10 years, dividends have increased by almost 19 percent on average per year . However, just like the earnings growth, the dividend growth has slowed as well (14 percent over a 5-year period).
KDDI’s revenue on the other hand has grown only 4.5 percent annually over the past 10 years, much slower than its profit. You may wonder how profits could be growing at a much higher rate than revenues. Stock buybacks can be a reason for this and KDDI does indeed buy back its own stock, but those buybacks alone cannot explain the profit increases, as their impact is too small. Dividendstocks.cash shows you what portion of profit growth is caused by share buybacks. As you can see in the chart, the profit increases can primarily attributed to organic growth. Stock buybacks are therefore not the main driver of KDDI’s earnings growth.
The answer for the increasing profit lies in the net margin which indicates what portion of revenues is converted into net profit. An increase in the net margin means that the ratio of costs to revenues has decreased. KDDI has increased its efficiency and has doubled its net margin within 10 years as a result. Higher margins make future revenue growth more valuable since a larger share of those additional revenues flow into the pockets of shareholders as profit.
Keep in mind that costs cannot be decreased indefinitely which means that those margin driven profit increases will slow or stop at some point in the future.
KDDI pays a semi-annual dividend which adds up to 1.14 dollars per year. At the current price this translates into a dividend yield of 3.5 percent. This is higher than the five-year average which means that the KDDI stock is undervalued from a dividend perspective.
KDDI is often overlooked as a dividend stock because its yield is lower than competitor´s. However, the pure size of the dividend yield is not the only thing that matters. One other important factor is dividend safety. KDDI has been increasing its dividend for 18 years straight. While KDDI does not yet qualify as a dividend aristocrat, this track record is impressive nevertheless.
Furthermore, the payout ratio of KDDI is a lot lower than those of other telecom companies. KDDI pays out just over 40 percent of its profits as a dividend. Other companies such as Vodafone and Telefonica frequently have payout ratios above 100 percent.
KDDI also generates high cash flow surpluses, as you can in the chart below. The so-called amortization power has been consistently positive for many years and has also been steadily increasing. In the current fiscal year, KDDI has used only a quarter of its free cash flow on dividends which leaves a large surplus to be used on other things such building up cash reserves or paying down debt.
Speaking of debt, you should not be shocked by the sudden debt increase in 2020. The customer deposits for the payment service that KDDI launched in 2019 are the reason of this increase. Since those funds belong to the customers and not KDDI, they are booked as a liability on the balance sheet. However, KDDI also receives money as a result, which in turn is listed on the assets side of the balance sheet. These deposits do not increase the interest burden of KDDI.
Thanks to its high cash flow surplus, KDDI could fully repay the debt within 7 years, even if these new liabilities were to be included.
KDDI is not in a rush to pay down the debt. Due to Japan’s extremely low interest rates, the interest that KDDI must pay on its debt is almost negligible. The financing costs (interest, losses from currency transactions, etc.) amounted to just 11,380 million yen in the last fiscal year on an operating profit of 1,025,237 million yen (page 60). Just one percent of the operating profit is used for the financing costs which is extremely low.
In my opinion, KDDI meets all the criteria of a solid dividend stock: a low payout ratio, stable cash flows and a barely noticeable interest burden.
The KDDI stock currently trades at a P/E ratio of 12 which is a rather low figure, considering we are in a time where valuations on the stock market are generally quite high. Usually, only companies with very low growth or with structural problems trade at such low P/E ratios. While KDDI is not growing like a young tech start-up, it still achieves decent growth rates in the mid-single digits. I do not see any structural issues either that would justify such a low valuation.
To value the stock, I use the Dynamic Stock Valuation and choose a valuation period of 10 years. The fair values for both cash flow and profit are almost identical to the current price of the stock which means that KDDI is fairly valued according to those measures. The fair value dividend, on the other hand, paints a completely different picture and implies an upside of 27 percent. The reason why the dividend fair value is much higher than the other fair values is that the dividend has grown much quicker than both earnings and cash flows in recent years. In addition to that, the stock currently has a much higher dividend yield that it did a couple of years ago. In 2015, the stock yielded around 2 percent compared the 3.5 percent yield of today. From a dividend perspective, the KDDI stock is clearly undervalued since you receive a much higher yield that you did in the past.
However, the dividend fair value could be misleading. As you can see in the chart, the stock was overvalued for a long time from 2013 to 2018 when measured by the dividend fair value. When the valuation for a stock increases, its dividend yield always decreases as a result. Therefore, the average yield over the valuation period is lower which makes it look like the stock is currently undervalued because of its comparatively high yield.
In my opinion, the slowing growth is the most plausible reason for the low valuation of the stock. Between 2014 and 2016, KDDI’s earnings per share grew quite quickly. Unsurprisingly, the price also rose significantly during this period. Investors accepted an initially lower dividend yield at that time, in hopes of big dividend hikes in the future. Once growth slowed down, it also brought down the valuation of the stock. For this reason, I would not use the dividend fair value as the only deciding factor when valuing KDDI. Taking everything into consideration, I consider the KDDI stock to be fairly valued right now.
KDDI is often overshadowed by its international competitors because of its exotic country of origin and comparatively low yield in the telecom sector. I think overlooking KDDI is a mistake. Stable margins combined with continuously rising revenues ensure high cash flows which in turn strengthens the dividend. In addition, I see further growth potential for KDDI, although at a slower pace than in the past. Those slowing growth rates are already priced into the stock which makes it an attractive purchase despite its lack of an undervaluation. Like Warren Buffett once said: “It’s far better to buy a wonderful company at a fair price, than a fair company at a wonderful price.”
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