SK Telecom: Positive signs emerging (NYSE:SKM)

I continue to comment SK Telecom Co., Ltd (NYSE:SKM) (017670:KS) shares as Buy. We saw positive signs related to SKM’s core mobile telecom business and the company’s growth initiatives related to artificial intelligence. SK Telecom’s current valuation figures indicate this the company’s stock has significant upside potential.

With my previous update on July 4, 2024, I pointed out that SKM is a leading telecom company in terms of “mobile market share” and “AI competitiveness”.

The core mobile telecom business benefited from initiatives to improve profitability

SKM’s latest quarterly financial performance was good due to improved profitability in its core mobile telecom business.

SK Telecom’s operating profit rose +16% year-on-year and +8% quarter-on-quarter to KRW 538 billion in the second quarter of this year, as revealed in its earnings presentation slides. Actual operation of SKM in Q2 2024 revenue represented a 4% beat according to consensus data from S&P Capital IQ.

The core business of mobile or wireless telecommunications contributed 84% of SKM’s operating income in Q2 2024. The company derived the remaining 16% of its operating profit in the second quarter from pay TV, landline services and other business B2B (Business-To-Business). The performance of SK Telecom’s core mobile telecommunications business has the biggest influence on the company’s overall results in the short term, as SKM’s wireless services accounted for the vast majority of operating profit.

Operating margin for SK Telecom’s mobile telecom business increased by +1.9 percentage points year-on-year from 12.2% in Q2 2023 to 14.1% for Q2 2024. This was the key driver SKM’s latest operating profit growth in Q2 2024.

SKM shared in its Q2 2024 analyst briefing that it has implemented initiatives to “sell high ARPU (Average Revenue Per User) price plans and attract high-end subscribers. they no longer compete on subsidies, but rather compete on price plans and differentiated benefits and services.”

In other words, competition has become less intense in South Korea’s mobile market, and this has allowed SK Telecom to market its premium wireless subscription packages. In particular, SKM’s mobile ARPU improved by +2.1% YoY to KRW 29,298 in Q2 2024.

On the other hand, SK Telecom noted in its second-quarter results presentation slides that its mobile telecommunications business achieved “cost stabilization” due to “efforts to improve operational efficiency.” In specific terms, SKM’s marketing and depreciation costs fell by -4% YoY to KRW 1.406 billion for the latest quarter.

Looking ahead, I believe that SKM is likely to post favorable financial results for the full fiscal year 2024.

One positive factor is that the Korean mobile phone market has already passed the phase of players aggressively competing for 5G subscribers. More than 70% of SKM’s mobile subscribers are on 5G wireless plans at the end of Q2 2024, implying that the 5G penetration level is reasonably high in South Korea. Therefore, SK Telecom and its rivals will most likely put more emphasis on monetizing existing 5G subscribers than cutting prices to attract new ones.

The other positive factor is that SK Telecom intends to continue with expense control and profit margin improvement initiatives in the near future. On the Q2 analyst call, SKM emphasized that it was “committed to improving the business bases of the fixed and mobile businesses through measures to optimize the efficiency of OpEx (operating expenses) and CapEx (capital expenses).”

I anticipate low-teens percentage growth in SK Telecom’s operating profit for FY24. In contrast, SKM expanded its operating income by a relatively more modest +9% to KRW 1.753 billion in the previous fiscal year or fiscal 2023. My positive expectation of accelerating operating profit growth for SKM this year is supported by improving competitive dynamics for the Korean wireless market and the company’s intent to optimize costs and capital investments.

Recent developments related to AI are favorable

Expanding the operating margin of SKM’s mobile telecommunications business will be the key driver of improving short-term financial performance for the company in the near term. In the medium to long term, SK Telecom’s AI-related offerings will be the major growth driver.

Recent developments suggest that it is only a matter of time before SK Telecom delivers on its AI growth initiatives.

First, SK Telecom’s revenue from its data center business and cloud services business grew strongly by +21% and +28% respectively in Q2 2024. At the company’s Q2 2024 results briefing , SKM attributed the strong growth in its data center business to “AI-driven demand” and revealed that its cloud services business “successfully won its first cloud AI order” last quarter.

Second, SKM has targeted an incremental AI-related revenue contribution of KRW 60 billion this year related to its offering of “generative AI, AICC (AI Call Center) and AI data advertising solutions for the financial sector and manufacturing,” according to its Q2 earnings. call comment. It serves as an example of how SK Telecom is exploring providing new B2B (Business-To-Business) AI offerings targeted at specific industries.

Third, the company’s B2C (Business-To-Consumer) AI product known as “A Dot” continued to gain significant traction. At the end of September last year, SK Telecom revealed the “official launch of” A Dot, which it described as an “AI personal assistant service”. An earlier CNBC news article from 2023 also referred to A Dot as SKM’s “artificial intelligence chatbot”. As revealed in SKM’s Q2 2024 results presentation, A Dot’s subscriber base grew by +155% to 4.6 million at the end of June this year, or nine months after its official launch. A growing number of subscribers for A Dot will give SK Telecom opportunities to monetize this B2C AI offering.

In my July 2024 article, I pointed out that SKM’s “AI competitiveness” will support its goal of increasing “the percentage of sales contributed by the company’s AI-related services and products from below 10% now to 36% by the fiscal year 2028”. The latest AI-related developments for SK Telecom mentioned above have increased my confidence in the growth prospects of the company’s AI-related businesses.

Variant view

There are specific risks to watch out for with SKM.

SK Telecom’s core mobile telecommunications business could perform poorly in the scenario where this business fails to manage costs well and competitive intensity in the Korean mobile service market increases.

SKM’s future AI revenue growth outlook could be more modest, assuming AI-related demand weakens in the future.

Conclusion

There are positives from the recent performance of SKM’s mobile telecom business and the latest metrics for the company’s AI-related offerings. But these positives have yet to be adequately reflected in SK Telecom’s valuations, and so I maintain my Buy rating on the stock.

Based on S&P Capital IQ data, SK Telecom is currently trading at 4x consensus trailing twelve month EV/EBITDA and offers a consensus trailing twelve month dividend yield of 6%. A general rule of thumb in valuation is that a stock is fairly valued if its earnings multiple is roughly equal to its earnings growth rate. SKM’s consensus FY 2023-2026 EBITDA CAGR estimate is +10% according to S&P Capital IQ, implying that a single-digit EV/EBITDA ratio for the stock will not be unreasonable. Also, SK Telecom’s dividend yield could compress to a low- to mid-single-digit percentage in the future when investors have a better appreciation of the company’s medium- to long-term growth prospects, driven by AI.