Early yesterday, China Telecom (NYSE:CHA), the larger of China's two fixed-line telecom operators, reported results that fell just shy of Street expectations, reinforcing my opinion that investors should put any plans to add to their positions on hold.
China Telecom announced that operating revenue (including connections costs) for the first half of 2006 came in at $10.9 billion, 3.5% more than last year, as the strong growth from the company's broadband business (up 35% to $1.36 billion) offset a 2.5% decline in sales from its traditional fixed-line business. (For currency translation purposes, $1 = 7.958 yuan.)
While I cheer any traditional telecom operator that can increase revenues in today's brutally competitive environment, very few of them can grow the top line without sacrificing margins. Unfortunately, China Telecom isn't one of them. The company reported net profits (again, including connection costs) of approximately $1.77 billion, down a little more than 4% from the first six months of 2005, and just below Street expectations of $1.8 billion.
Net margins decreased 130 basis points to 16.2%. The drop was due to higher operating expenses (up 5.5%), led by a 15% increase in SG&A costs. Margins should remain under pressure in the near term; the company intends to increase its marketing to compete with rival China Netcom (NYSE:CN) in the fixed-line business and stem losses of customers to cell-phone operators like China Mobile (NYSE:CHL) and China Unicom (NYSE:CHU).
And did I mention that management also decided not to pay an interim dividend?
I don't think these results were bad per se -- after all, China Netcom recently saw its profits fall almost 8% -- but they simply weren't solid enough to make me comfortable adding to, let alone initiating, a position. Given the continued deterioration in net margins, the uncertainty regarding the timing of the issuance of 3G mobile licenses (which the company is counting on to compete more effectively with cellular giant China Mobile), and its obvious concern about paying for the rollout of the 3-G network -- remember, no interim dividend this year -- I'd suggest that investors might want to sit on the sidelines until the proverbial connection clears up.
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Fool contributor Will Frankenhoff does not own shares in any of the companies mentioned above. The Fool has a disclosure policy.
