Profitability is one of the main factors to look at when analyzing a company. It’s not only the reason behind a company’s existence, but also a key element when determining whether to invest in a company. Thus, in this article I will look into China Mobile Ltd. ADR (CHL)’s earnings, profit margins, profitability ratios and cash flow. Additionally, I will evaluate which institutional investors bought the stock in the recent quarters (institutional backup can tell a lot about a stock).
China Mobile’s subscriber base is the largest worldwide, with 600 million customers. As China’s main provider of wireless voice and value-added services through GSM networks, the company has achieved massive scale and very strong brand recognition over the past few years. Despite its 3G network being handicapped by the mandate to use less mature TD technology, the company is focused on continuing its innovative pattern. Thus, the company’s 4G services will be launched as soon as licensing is completed, and the new equipment is bound to boost profits.
The first step is analyzing China Mobile’s earnings growth. I am looking for companies that are able to expand both their quarterly and annual earnings by more than 15% a year. That growth could come either from new product introductions or a solid strategy of expansion into new markets.
China Mobile’s generated 7% quarterly EPS growth in Q4 of FY 2013, when compared to the same quarter last year. I am not encouraged by the firm’s growth rate, since past growth winners (Apple Inc. (AAPL), Baidu Inc. (ADR) (BIDU), etc.) generated consistent quarterly EPS growth above 15% and I am certainly looking for that level before investing.
However, it’s interesting to see that consensus analysts recently upgraded their estimates for the current year, increasing their EPS projections by 44.81%, which shows that sell-side analysts are confident in the company. Nevertheless, China Mobile generated 3 year average annual EPS growth of 3.90%, which is well below my expectancy rate of 15%.
Let’s take a look now at the company’s revenue growth. This is a key metric that needs to be analyzed before investing in a company, as it is one of the scarce figures that cannot be modified through accounting tricks and similar dodges. China Mobile generated 27% quarterly revenue growth compared to the same period last year. As I require a minimum revenue growth rate of 15% for these kind of companies, I am encouraged by the firm’s reported revenue.
I also find the fact that revenues grew more than earnings per share very encouraging, because if a company generates strong EPS growth levels and even stronger revenue growth, I tend to feel very bullish about it. China Mobile generated quarterly EPS growth of 7%, while sales grew by 27%.
Furthermore, when betting on a company, an investor wants to see sales grow or improve over time -and not just in the last reported quarter. In this firm’s case, the 3 year average annual sales grew at a relatively poor rate of 7.42%.
Gross Profit Margin
The gross profit margin reflects a company's manufacturing and distribution efficiency during the production process. It also tells an investor the percentage of revenue/sales left after subtracting the cost of the goods/services sold. A company that operates on a higher profit margin than its competitors is more efficient and investors tend to pay more for these businesses, given their ability to make a decent profit as long as overhead costs are controlled.
In reviewing China Mobile's gross margin over the past five years, it’s evident that the company's ratio has been decreasing. In fact, the 5-year low for the gross margin was reported at 93.7%, while the 5-year high for this ratio was achieved over the past twelve months, when the margin reached 94.7%. However, the TTM gross profit margin of 91.1% is below the 5-year average of 94.3%, implying that management has been inefficient in improving this key profitability metric.
Operating Margin = Operating Income / Total Sales
The operating margin measures the proportion of a company's revenue that is left over after paying for variable costs of production. A healthy operating margin is required for a company to be able to pay for its fixed costs, such as interest on debt. If a company's margin is increasing, it is earning more per dollar of sales. Needless to say: the higher the margin, the better.
Over the past 5 years, China Mobile’s operating margin has been decreasing. While the company reported an operating margin of 34.6% in 2009, the current TTM operating margin stands at 25.2%. Moreover, as this metric is below the 5-year average of 30.76%, it implies that there has been a reduction in the percentage of the total sales left over after paying for variable costs of production compared to the 5-year average. I always stress that it is essential to find companies with improving profit margins, as it’s a sign that the company is gaining profitability.
Net Profit Margin = Net Income / Total Sales
This ratio measures how much out of every dollar of sales a company actually keeps in earnings. The profit margin is very useful when comparing companies in the same –or similar- industries. A higher profit margin indicates that a company has better control over its costs, compared to its competitors.
Over the past 5 years, China Mobile's net profit margin shrank, when compared to the 5 year average. The TTM net profit margin of 22.10% is smaller than the 5-year average of 24.88%, implying that there’s been a decline in the percentage of earnings that the company is able to keep compared to the company's 5-year average.
ROA - Return on Assets = Net Income / Total Assets
ROA is an indicator of how profitable a company is relative to its total assets. Calculated by dividing a company's net income by its total assets, ROA is displayed as a percentage and it oftentimes referred to as "returns on investment".
China Mobile’s 2012 ROA of 12.17% is slightly below the 5-year average of 15.28%, which implies that management’s ability to use the company's assets to generate earnings over the past five years has decreased.
Free Cash Flow = Operating Cash Flow - Capital Expenditure
Free cash flow (FCF) represents the cash that a company is able to generate after laying out the money required to maintain or expand its asset base. This metric is important because it allows a company to pursue opportunities that enhance shareholder value. Without cash, it's tough to develop new products, make acquisitions, pay dividends and reduce debt.
China Mobile generated a ratio of cash flow from operations/total sales of 19.15, which is very solid considering that it vastly surpasses the firm’s debt levels and cost of capital. Usually, a firm with high cash flow and almost no debt will result in healthy shareholder returns, making it an attractive investment.
Several institutional investors have been buying China Mobile’s stock in the recent quarters. This is important because hedge funds use strict fundamental procedures before investing in a stock. I feel encouraged by the fact that investment gurus Jim Simons (Trades, Portfolio) and Joel Greenblatt (Trades, Portfolio) bought the stock this past quarter, at an average price of $54.06, because it shows that hedge funds are confident about the firm’s future profitability.
Furthermore, many analysts currently have a good outlook for China Mobile. Analysts at Bloomberg, for example, estimate the firm's revenue to jump significantly from 2013’s $46.94 billion to $60.20 billion for FY 2014.
Despite some weakness in China Mobile’s balance sheet, I remain bullish about the company’s long term profitability. Not only because of the consistent revenue growth and healthy cash flow situation, but because management has proven clever in targeting China’s rural areas to add subscriber growth. While rivalry remains a real threat to the mobile carrier, its scale advantage and 4G service launch should allow China Mobile to sustain healthy growth and profits for the medium term future, at the least. Moreover, with the stock currently trading at a bargain price discount of 48% relative to the industry average of 16.8x, I believe investors would be smart to buy the company’s shares now, before the price increases.
Disclosure: Damian Illia holds no position in any stocks mentioned.