China Telecom 728 HK Outperform 2016: Capex Cut, but Not Deep Enough Price (At 05:20, 22 Mar 2016 GMT) HK$3.90

HONG KONG China Telecom 728 HK Outperform 2016: capex cut, but not deep enough Price (at 05:20, 22 Mar 2016 GMT) HK$3.90

Valuation HK$ 4.30 Event - DCF 12-month target HK$ 4.30 . China Telecom’s 2015 net profit came in ahead of market expectations. We Upside/Downside % +10.3 believe guidance for a capex cut is not deep enough to impress the market. 12-month TSR % +12.5 Volatility Index Medium Impact GICS sector . Financial highlights. For 2015, China Telecom reported operating revenues Telecommunication Services of RMB331.2bn (+2.1% y-y), EBITDA of RMB94.1bn (-0.8% y-y) and net profit Market cap HK$m 315,636 of RMB20.1bn (+13.4% y-y). We note the company’s net profit came in ~5% Market cap US$m 41,022 30-day avg turnover US$m 21.6 above market expectation. The company declared final DPS of HK$0.095 Number shares on issue m 80,932 (2014: HK$0.095).

Investment fundamentals . Positive: While the mobile service revenue for Mobile and Unicom fell Year end 31 Dec 2014A 2015E 2016E 2017E 1.2% and 8.0% y-y, respectively, Telecom reported +3.5% y-y for its Revenue bn 324.4 351.8 380.6 400.7 mobile service revenue. Due to implementation of VAT and “one-month EBIT bn 28.5 30.4 36.0 42.2 EBIT growth % 3.8 6.8 18.4 17.2 mobile data carry-over” initiative, mobile service revenue for domestic Reported profit bn 17.7 20.5 24.6 29.3 operators were under pressure in 2015. One bright spot of China Telecom is Adjusted profit bn 17.7 20.5 24.6 29.3 EPS rep Rmb 0.22 0.25 0.30 0.36 its mobile service revenue grew y-y while the other two operators’ mobile EPS rep growth % 0.8 16.1 19.7 19.2 service revenue fell y-y. EPS adj Rmb 0.22 0.25 0.30 0.36 EPS adj growth % 0.8 16.1 19.7 19.2 . Positive: China Telecom still has work to do in terms of enhancing its PER rep x 14.9 12.8 10.7 9.0 PER adj x 14.9 12.8 10.7 9.0 4G ARPU. For 2015, China Telecom’s 4G ARPU was RMB78. Recall, the Total DPS Rmb 0.08 0.08 0.08 0.08 comparative figures for China Mobile and China Unicom were RMB85 and Total div yield % 2.3 2.3 2.3 2.3 ROA % 5.2 5.3 6.0 6.7 RMB88. As Telecom aims to expand its 4G subscriber base by another 60m ROE % 6.2 6.9 7.9 8.8 in 2016, we believe the key is whether the company can enhance its 4G EV/EBITDA x 3.7 3.5 3.3 3.1 Net debt/equity % 29.4 33.4 33.0 27.1 ARPU (via higher data usage). P/BV x 0.9 0.9 0.8 0.8 . Negative: China Telecom guided its capex to drop 11.1% y-y in 2016. We 728 HK rel HSI performance, & rec believe the market may not be satisfied with the magnitude. Recall, China history Telecom began its 4G rollout much earlier than China Unicom. While Unicom is guiding for 44% y-y decline of its capex spend to RMB75bn, Telecom is only guiding for 11% y-y decline of capex spend. In our view, the market may not be satisfied with the capex cut. The street may interpret the capex efficiency is not optimal at China Telecom. Earnings and target price revision

. Our estimates are under review.

Note: Recommendation timeline - if not a continuous line, then there was no Macquarie coverage at the time or there was an embargo period. Price catalyst Source: FactSet, Macquarie Research, March 2016 (all figures in Rmb unless noted, TP in HKD) . 12-month price target: HK$4.30 based on a DCF methodology.

. Catalyst: 1Q16 results to be released in late April.

Analyst(s) Action and recommendation Macquarie Capital Limited Danny Chu, CFA . In 2016, we expect: (1) lower-than-expected ARPU uplift after the launch of +852 3922 4762 [email protected] 4G service; (2) stagnant revenue trends of the wireline business; (3) lack of Susana So +852 3922 1108 [email protected] material EBITDA margin expansion; (4) capex remaining at a high level and Macquarie Capital Securities (Japan) Limited becoming a drag on free cashflow; (5) potential slowdown of transformation Nathan Ramler, CFA due to loss of key management. +81 3 3512 7875 [email protected]

23 March 2016

Please refer to page 9 for important disclosures and analyst certification, or on our website www.macquarie.com/research/disclosures.

Macquarie Research China Telecom

For 2015, China Telecom reported operating revenues of RMB331.2bn (+2.1% y-y), EBITDA of RMB94.1bn (-0.8% y-y) and net profit of RMB20.1bn (+13.4% y-y). With the company’s operating revenues, we note mobile service revenues came in at RMB124.5bn (+3.5% y-y) while wireline service revenues came in at RMB168.8bn (+1.0% y-y). We note the company’s net profit came in ~5% above market expectation. The company declared final DPS of HK$0.095 (2014: HK$0.095). Key takeaways from results and analyst briefing We present our three major takeaways from China Telecom’s 2015 financial results: While the mobile service revenue for Mobile and Unicom fell 1.2% and 8.0% y-y, respectively, Telecom reported +3.5% y-y for its mobile service revenue. Due to implementation of VAT and “one-month mobile data carry-over” initiative, mobile service revenue for domestic operators were under pressure in 2015. One bright spot of China Telecom is its mobile service revenue grew y-y while the other two operators’ mobile service revenue fell y-y. China Telecom still has work to do in terms of enhancing its 4G ARPU. For 2015, China Telecom’s 4G ARPU was RMB78. Recall, the comparative figures for China Mobile and China Unicom were RMB85 and RMB88. As Telecom aims to expand its 4G subscriber base by another 60m in 2016, we believe the key is whether the company can enhance its 4G ARPU (via higher data usage). China Telecom guided its capex to drop 11.1% y-y in 2016. We believe the market may not be satisfied with the magnitude. Recall, China Telecom began its 4G rollout much earlier than China Unicom. While Unicom is guiding for 44% y-y decline of its capex spend to RMB75bn, Telecom is only guiding for 11% y-y decline of capex spend. In our view, the market may not be satisfied with the capex cut. The street may interpret the capex efficiency is not optimal at China Telecom.

Fig 1 China Telecom – quarterly financial results 1Q14 2Q14 3Q14 4Q14 1Q15 2Q15 3Q15 4Q15 FY14 FY15

Revenue (RMB m) 83,184 82,789 77,635 80,786 81,453 83,500 81,364 84,885 324,394 331,202 q-q change (%) (0.3) (0.5) (6.2) 4.1 0.8 2.5 (2.6) 4.3 y-y change (%) 6.9 3.9 (3.8) (3.1) (2.1) 0.9 4.8 5.1 2.1

EBITDA (RMB m) 25,085 25,453 24,255 20,060 24,525 26,214 25,774 17,593 94,853 94,106 q-q change (%) 14.8 1.5 (4.7) (17.3) 22.3 6.9 (1.7) (31.7) y-y change (%) 0.6 1.1 (1.4) (8.2) (2.2) 3.0 6.3 (12.3) (0.8)

EBITDA margin (%) 30.2 30.7 31.2 24.8 30.1 31.4 31.7 20.7 29.2 28.4

Net profit (RMB m) 5,547 5,889 4,733 1,511 5,046 5,934 5,381 3,693 17,680 20,054 q-q change (%) 95.9 6.2 (19.6) (68.1) 234.0 17.6 (9.3) (31.4) y-y change (%) 18.1 6.7 5.2 (46.6) (9.0) 0.8 13.7 144.4 13.4 Source: Company data, Macquarie Research, March 2016

23 March 2016 2 Macquarie Research China Telecom

As China Telecom rolled out its 4G network (FDD LTE technology) faster than China Unicom, China Telecom’s 4G subscriber base benefited. Since mid-2014, China Telecom began its active rollout of 4G network (based on FDD LTE technology). We believe China Unicom began its 4G network rollout in late 2014/early 2015. Due to China Telecom’s earlier 4G network rollout, the company gained 51.4m 4G net adds in 2015 (2014: 7.1m). At the analyst briefing, the company management indicated China Telecom’s target is to add ~60m 4G net adds in 2016.

Fig 2 China Telecom – mobile subscriber base (2G/3G/4G) (m) 1Q14 2Q14 3Q14 4Q14 1Q15 2Q15 3Q15 4Q15 FY14 FY15

Mobile subs 183.2 180.2 181.6 185.6 188.8 191.4 194.3 197.9 185.6 197.9 Net adds (2.4) (3.0) 1.3 4.0 3.2 2.6 2.9 3.6 0.0 12.3

2G subs 79.1 73.0 69.1 67.0 64.0 60.4 57.5 54.8 67.0 54.8 Net adds (3.4) (6.1) (3.9) (2.1) (3.0) (3.5) (2.9) (2.8) (15.5) (12.2)

3G subs 104.1 107.2 111.2 111.6 108.1 102.0 93.1 84.7 111.6 84.7 Net adds 1.0 3.1 3.9 0.4 (3.5) (6.1) (8.9) (8.4) 8.4 (26.9)

4G subs 0.0 0.0 1.3 7.1 16.8 29.0 43.7 58.5 7.1 58.5 Net adds 0.0 0.0 1.3 5.8 9.7 12.3 14.7 14.7 7.1 51.4 Source: Company data, Macquarie Research, March 2016

Blended ARPU moved up slightly. 2015’s blended ARPU grew +0.2% y-y. We believe the implementation of VAT (VAT effective since 1 June 2014) and “one-month mobile data carry-over” initiative have exerted pressure upon mobile operators’ blended ARPU. Given mobile data consumption (per subscriber) is still quite below other regions, we believe there is still room for its growth. In the process, we expect China Telecom’s blended ARPU to continue its mild upward trend.

Fig 3 China Telecom – blended ARPU trend (RMB) 1Q14 2Q14 3Q14 4Q14 1Q15 2Q15 3Q15 4Q15 FY14 FY15

ARPU 55.5 57.4 53.9 52.7 53.5 56.7 56.2 50.3 54.0 54.1 q-q change (%) 1.3 3.4 (6.1) (2.2) 1.4 6.0 (0.7) (10.5) y-y change (%) 2.8 5.4 (0.9) (3.8) (3.7) (1.2) 4.4 (4.5) 0.2 Source: Company data, Macquarie Research, March 2016

S&M (selling and marketing expenses) continued its downward trend in 2015. Back in mid- 2014, the government asked all three telecom operators to stringently control their selling and marketing expenses. For 2015, we note China Telecom’s selling and marketing expenses went down by 15.7% y-y.

Fig 4 China Telecom – selling and marketing expenses (as % of operating revenue) (RMB m) 2011 2012 2013 2014 2015

S&M expenses 41,236 54,442 62,010 54,489 45,943 % of operating rev 16.8 19.2 19.3 16.8 13.9 Source: Company data, Macquarie Research, March 2016

23 March 2016 3 Macquarie Research China Telecom

Fig 5 Operating expenses as % of operating revenue

100

90 8.4 11.2 10.9 7.9 11.1 10.8 9.7 10.2 80 5.9 6.3 3.3 4.2 5.9 6.3 5.1 4.2 70 16.3 17.7 21.2 23.3 15.2 21.6 22.3 60 22.2 16.4 17.0 14.7 50 15.5 14.7 14.2 14.9 14.8 40 24.8 26.5 30 22.6 24.0 14.8 18.1 17.7 22.6 20 10 17.8 17.3 22.0 21.0 19.7 21.2 20.4 20.5 0 1H12 2H12 1H13 2H13 1H14 2H14 1H15 2H15

Dep'n Network Ops Personnel SG&A Interconnection COGS

Note: Operating revenue includes mobile terminal sales. Source: Company data, Macquarie Research, March 2016

As Unicom lowered its 2016 capex budget significantly, Telecom lowered its 2016 capex budget as well. As a beneficiary of the strategic cooperation agreement between Telecom and Unicom, China Telecom announced its 2016 capex budget to be RMB97bn (~11.1% lower than 2015’s level). In our view, the scaling down of capex at China Telecom could benefit the company in at least two ways: (1) strengthening of free cash flow; (2) lowering of depreciation expense in the future. However, we believe the market may be unsatisfied with the extent of capex cut at China Telecom.

Fig 6 China Telecom – composition of capex spend Composition (%) 2010 2011 2012 2013 2014 2015 2016E

Wireline voice 2.4 1.4 1.2 0.0 0.0 0.0 IT & support 2.9 3.6 4.0 4.0 4.5 3.3 VAS 13.9 13.5 13.1 8.3 8.3 5.7 Infrastructure & others 16.6 14.7 14.8 9.8 14.6 9.8 B'band & Internet 64.2 66.8 66.9 41.2 34.2 34.3 Mobile 0.0 0.0 0.0 36.7 38.4 46.9 47.4

Capex (RMB bn) 43.0 49.6 53.7 80.0 76.9 109.1 97.0 y-y change (%) 13.1 15.1 8.4 48.9 (3.9) 41.9 (11.1) Source: Company data, Macquarie Research, March 2016

DPS stayed flat for 2015. Lower capex budget implies better potential for higher payout ratio in future. For 2015, China Telecom declared final DPS of HK$0.095 (same as last year). Based on the final DPS declared, the payout ratio for 2015 is 32% (2014: 35%). Given China Telecom is guiding for a lower capex spend in 2016, we expect the company’s free cash flow to improve in the near future. As its free cash flow will improve, we believe the company should be in a better position to enhance its earnings payout ratio.

23 March 2016 4 Macquarie Research China Telecom

Fig 7 CT – Dividend per share and payout ratio Fig 8 CT – subscriber composition and ARPU

(HK$) (%) (%) (RMB)

0.10 45 100 58

0.09 40 90 56 0.08 80 35 46 50 53 0.07 70 56 57 59 30 62 64 66 54 68 70 72 0.06 60 25 0.05 0.095 0.095 0.095 50 52 20 0.04 0.085 0.085 0.085 0.085 0.085 0.085 0.085 40 15 50 0.03 30 54 50 47 0.02 10 20 44 43 41 38 36 34 48 32 30 28 0.01 5 10 0.00 0 0 46 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 1Q13 2Q13 3Q13 4Q13 1Q14 2Q14 3Q14 4Q14 1Q15 2Q15 3Q15 4Q15

DPS Payout ratio (RHS) 2G subs 3G/4G subs ARPU (RHS)

Source: Company data, Macquarie Research, March 2016 Source: Company data, Macquarie Research, March 2016

Redeployment of 800MHz for 4G use? At the analyst briefing, China Telecom mentioned that it may refarm its 800MHz spectrum for 4G usage in 2016. From the following figure, our concern is given China Telecom still has massive number of subscribers on its 2G network (currently using the 800MHz spectrum). Therefore, we are cautious whether the 800MHz can be made vacant for spectrum refarming. In fact, China Mobile is facing the same issue. On one hand, China Mobile would like to conduct spectrum refarming. However, China Mobile is still having enormous amount of subscribers on its 2G network.

Fig 9 Frequency spectrum allocation Start (MHz) End (MHz) Remarks Start (MHz) End (MHz) Remarks

825 835 China Telecom 2G (uplink) 1785 1805 Aviation 870 880 China Telecom 2G (downlink) 1805 1830 China Mobile GSM (downlink) 885 890 China Mobile EGSM (uplink) 1830 1845 China Unicom GSM (downlink) 890 909 China Mobile GSM (uplink) 1845 1860 China Unicom FDD LTE (downlink) 909 915 China Unicom GSM (uplink) 1860 1875 China Telecom FDD LTE (downlink) 930 935 China Mobile EGSM (downlink) 1875 1880 Unallocated 935 954 China Mobile GSM (downlink) 1880 1900 China Mobile TD-SCDMA / TD-LTE 954 960 China Unicom GSM (downlink) 1900 1920 PAS 1710 1735 China Mobile GSM (uplink) 1920 1935 China Telecom 3G (uplink) 1735 1750 China Unicom GSM (uplink) 1935 1940 Unallocated 1750 1765 China Unicom FDD LTE (uplink) 1940 1955 China Unicom 3G (uplink) 1765 1780 China Telecom FDD LTE (uplink) 1980 2010 Satellite 1780 1785 Unallocated 2010 2025 China Mobile TD-SCDMA 2110 2125 China Telecom 3G (downlink) Operator Standard Bandwidth (MHz) 2125 2130 Unallocated CM - 2G GSM 98 2130 2145 China Unicom 3G (downlink) CM - 3G TD-SCDMA 15 2145 2170 Unallocated CM - 4G TD-LTE 130 2300 2320 China Unicom TD-LTE (indoor) CT - 2G CDMA 20 2320 2370 China Mobile TD-SCDMA / TD-LTE CT - 3G EV-DO 30 2370 2390 China Telecom TD-LTE (indoor) CT - 4G TD-LTE 40 2500 2555 Unallocated CT - 4G FDD LTE 30 2555 2575 China Unicom TD-LTE (outdoor) CU - 2G GSM 42 2575 2635 China Mobile TD-LTE (outdoor) CU - 3G WCDMA 30 2635 2655 China Telecom TD-LTE (outdoor) CU - 4G TD-LTE 40 2655 2690 Unallocated CU - 4G FDD LTE 30 Source: Company data, Ministry of Industry and Information Technology (MIIT), Macquarie Research, March 2016

23 March 2016 5 Macquarie Research China Telecom

Fig 10 CT – 12-month forward PE band chart Fig 11 CT – 12-month forward EV/EBITDA band chart

(HK$) (HK$)

6 6

5 5

4 4

3 3

2 2

13 14 15

13 15 14

13 14 15

14 15 13

13 15 14

13 14 14 15 13 15

13 13 15 15 14 14

14 15 13

13 14 15

- - -

Jul Jul Jul

Jan Jan Jan

Mar Mar Mar

Sep Sep Sep

Nov Nov Nov

May May May

Price 11.5 13 14.5 16 17.5 Price 3 3.5 4 4.5 5

Source: Bloomberg, Macquarie Research, March 2016 Source: Bloomberg, Macquarie Research, March 2016

Catalysts In the short-term (<12 months), we believe catalysts that could drive the share price include: . Continuous uplift of blended ARPU (mobile business), as this suggests China Telecom is bringing in good quality 4G subscribers; . Higher growth rate of wireline services revenue, as this generates robust operating cashflow for China Telecom’s other businesses; . Emerging businesses (e.g. data traffic, ICT, Internet applications) becoming more sizable, as their revenue generates higher-than-average growth rate; . Introduction of new business initiatives by senior management, as this reassures investors that the company has not lost its momentum despite its former chairman joining a rival company (China Unicom). In the long-term (>12 months), we believe catalysts that could drive the share price include: . Higher payout ratio to enhance shareholders’ return; . More disciplined approach towards capex spend to drive for a more robust free cash flow; . The tower company (China Tower Corporation), which may help China Unicom to lower its capex spend; . Regulatory roadmap to be drawn out by Ministry of Industry and Information Technology.

Other companies mentioned in this report: China Mobile (941 HK, HK$83.80, Outperform, TP: HK$115.00) China Unicom (762 HK, HK$9.92, Outperform, TP: HK$14.80)

23 March 2016 6 Macquarie Research China Telecom Macquarie Quant View

The quant model currently holds a strong positive view on China Telecom. Attractive Displays where the The strongest style exposure is Valuations, indicating this stock is under- company’s ranked based on

priced in the market relative to its peers. The weakest style exposure is s

l the fundamental consensus a

Profitability, indicating this stock is not efficiently converting its investments t

n Price Target and to earnings as proxied by ratios such as ROE, ROA etc. e

Macquarie’s Quantitative m

a Alpha model.

20/174 d n

u Two rankings: Local market Global rank in F (China) and Global sector Telecommunication Services (Telecommunication Quant % of BUY recommendations 58% (15/26) Services) Local market rank Global sector rank Number of Price Target downgrades 6 Number of Price Target upgrades 3

Macquarie Alpha Model ranking Factors driving the Alpha Model A list of comparable companies and their Macquarie Alpha model score For the comparable firms this chart shows the key underlying styles and their (higher is better). contribution to the current overall Alpha score.

HKT Trust 2.0 HKT Trust

China Communications Serv… 1.6 China Communications Serv…

China Telecom 1.3 China Telecom

SmarTone Telecommunicatio… 1.0 SmarTone Telecommunicatio…

China Mobile 0.8 China Mobile

China Unicom 0.4 China Unicom

Hutchison Telecommunicati… 0.1 Hutchison Telecommunicati…

-100% -80% -60% -40% -20% 0% 20% 40% 60% 80% 100% -3.0 -2.0 -1.0 0.0 1.0 2.0 3.0 Valuations Growth Profitability Earnings Price Quality Momentum Momentum

Macquarie Earnings Sentiment Indicator Drivers of Stock Return The Macquarie Sentiment Indicator is an enhanced earnings revisions Breakdown of 1 year total return (local currency) into returns from dividends, changes signal that favours analysts who have more timely and higher conviction in forward earnings estimates and the resulting change in earnings multiple. revisions. Current score shown below.

HKT Trust HKT Trust 1.0 China Communications Serv… China Communications Serv… -0.3 China Telecom China Telecom 0.1 SmarTone Telecommunicatio… SmarTone Telecommunicatio… -0.3 China Mobile China Mobile 0.0

China Unicom -0.4 China Unicom

Hutchison Telecommunicati… -0.2 Hutchison Telecommunicati…

-3.0 -2.0 -1.0 0.0 1.0 2.0 3.0 -40% -30% -20% -10% 0% 10% 20% 30% 40% Dividend Return Multiple Return Earnings Outlook 1Yr Total Return

What drove this Company in the last 5 years How it looks on the Alpha model Which factor score has had the greatest correlation with the company’s A more granular view of the underlying style scores that drive the alpha (higher is returns over the last 5 years. better) and the percentile rank relative to the sector and market. ⇐ Negatives Positives ⇒ Normalized Percentile relative Percentile relative Dividend Yield FY0 24% Score to sector(/174) to market(/818) Alpha Model Score 1.29 Asset Turnover 22% Valuation 0.80 Dividend Yield FY1 21% Growth -0.05 Dividend Yield LTM 21% Profitability -0.52 Earnings Momentum 0.06 Return on Assets NTM -23% Price Momentum -0.15 Net Income Margin NTM -26% Quality 0.12 Capital & Funding 0.37 Turnover (USD) 250 Day -29% Liquidity 0.11 Turnover(USD) 125 Day -34% Risk 0.18 Technicals & Trading -0.62 -40% -20% 0% 20% 40% 0 50 100 0 50 100 0 0 1 1

Source (all charts): FactSet, Thomson Reuters, and Macquarie Research. For more details on the Macquarie Alpha model or for more customised analysis and screens, please contact the Macquarie Global Quantitative/Custom Products Group ([email protected])

23 March 2016 7 Macquarie Research China Telecom

China Telecom (728 HK, Outperform, Target Price: HK$4.30) Interim Results 2H/14A 1H/15E 2H/15E 1H/16E Profit & Loss 2014A 2015E 2016E 2017E

Revenue m 162,197 175,880 175,880 190,286 Revenue m 324,394 351,760 380,572 400,684 Gross Profit m 162,197 175,880 175,880 190,286 Gross Profit m 324,394 351,760 380,572 400,684 Cost of Goods Sold m 0 0 0 0 Cost of Goods Sold m 0 0 0 0 EBITDA m 47,427 50,219 50,219 52,768 EBITDA m 94,853 100,438 105,537 111,250 Depreciation m 33,173 35,000 35,000 34,750 Depreciation m 66,345 70,000 69,500 69,000 Amortisation of Goodwill m 0 0 0 0 Amortisation of Goodwill m 0 0 0 0 Other Amortisation m 0 0 0 0 Other Amortisation m 0 0 0 0 EBIT m 14,254 15,219 15,219 18,018 EBIT m 28,508 30,438 36,037 42,250 Net Interest Income m -2,646 -1,483 -1,483 -1,580 Net Interest Income m -5,291 -2,966 -3,160 -3,090 Associates m 17 17 17 17 Associates m 34 34 34 34 Exceptionals m 0 0 0 0 Exceptionals m 0 0 0 0 Forex Gains / Losses m 0 0 0 0 Forex Gains / Losses m 0 0 0 0 Other Pre-Tax Income m 3 3 3 3 Other Pre-Tax Income m 6 6 6 6 Pre-Tax Profit m 11,629 13,756 13,756 16,458 Pre-Tax Profit m 23,257 27,512 32,917 39,200 Tax Expense m -2,749 -3,439 -3,439 -4,115 Tax Expense m -5,498 -6,878 -8,229 -9,800 Net Profit m 8,880 10,317 10,317 12,344 Net Profit m 17,759 20,634 24,688 29,400 Minority Interests m -40 -50 -50 -50 Minority Interests m -79 -100 -100 -100

Reported Earnings m 8,840 10,267 10,267 12,294 Reported Earnings m 17,680 20,534 24,588 29,300 Adjusted Earnings m 8,840 10,267 10,267 12,294 Adjusted Earnings m 17,680 20,534 24,588 29,300

EPS (rep) 0.11 0.13 0.13 0.15 EPS (rep) 0.22 0.25 0.30 0.36 EPS (adj) 0.11 0.13 0.13 0.15 EPS (adj) 0.22 0.25 0.30 0.36 EPS Growth yoy (adj) % 0.8 16.1 16.1 19.7 EPS Growth (adj) % 0.8 16.1 19.7 19.2 PE (rep) x 14.9 12.8 10.7 9.0 PE (adj) x 14.9 12.8 10.7 9.0

EBITDA Margin % 29.2 28.6 28.6 27.7 Total DPS 0.08 0.08 0.08 0.08 EBIT Margin % 8.8 8.7 8.7 9.5 Total Div Yield % 2.3 2.3 2.3 2.3 Earnings Split % 50.0 50.0 50.0 50.0 Basic Shares Outstanding m 80,932 80,932 80,932 80,932 Revenue Growth % 0.9 8.4 8.4 8.2 Diluted Shares Outstanding m 80,932 80,932 80,932 80,932 EBIT Growth % 3.8 6.8 6.8 18.4

Profit and Loss Ratios 2014A 2015E 2016E 2017E Cashflow Analysis 2014A 2015E 2016E 2017E

Revenue Growth % 0.9 8.4 8.2 5.3 EBITDA m 94,853 100,438 105,537 111,250 EBITDA Growth % -1.8 5.9 5.1 5.4 Tax Paid m -5,422 -5,498 -6,878 -8,229 EBIT Growth % 3.8 6.8 18.4 17.2 Chgs in Working Cap m 6,690 5,287 5,566 3,886 Gross Profit Margin % 100.0 100.0 100.0 100.0 Net Interest Paid m -5,291 -2,966 -3,160 -3,090 EBITDA Margin % 29.2 28.6 27.7 27.8 Other m 0 0 0 0 EBIT Margin % 8.8 8.7 9.5 10.5 Operating Cashflow m 90,830 97,261 101,065 103,816 Net Profit Margin % 5.5 5.8 6.5 7.3 Acquisitions m 0 0 0 0 Payout Ratio % 34.4 29.6 24.7 20.7 Capex m -80,000 -107,800 -100,000 -85,000 EV/EBITDA x 3.7 3.5 3.3 3.1 Asset Sales m 0 0 0 0 EV/EBIT x 12.2 11.4 9.7 8.2 Other m 0 0 0 0 Investing Cashflow m -80,000 -107,800 -100,000 -85,000 Balance Sheet Ratios Dividend (Ordinary) m -6,098 -6,085 -6,074 -6,074 ROE % 6.2 6.9 7.9 8.8 Equity Raised m 0 0 0 0 ROA % 5.2 5.3 6.0 6.7 Debt Movements m 0 0 0 0 ROIC % 5.9 6.1 6.7 7.4 Other m 2,126 40 40 40 Net Debt/Equity % 29.4 33.4 33.0 27.1 Financing Cashflow m -3,972 -6,045 -6,034 -6,034 Interest Cover x 5.4 10.3 11.4 13.7 Price/Book x 0.9 0.9 0.8 0.8 Net Chg in Cash/Debt m 6,858 -16,584 -4,969 12,782 Book Value per Share 3.6 3.8 4.0 4.3 Free Cashflow m 10,830 -10,539 1,065 18,816

Balance Sheet 2014A 2015E 2016E 2017E

Cash m 21,815 5,231 262 13,044 Receivables m 21,562 23,381 25,296 26,633 Inventories m 4,225 4,581 4,957 5,219 Investments m 0 0 0 0 Fixed Assets m 372,876 410,676 441,176 457,176 Intangibles m 29,917 29,917 29,917 29,917 Other Assets m 110,879 110,879 110,879 110,879 Total Assets m 561,274 584,665 612,487 642,868 Payables m 88,458 95,920 103,777 109,261 Short Term Debt m 44,058 44,058 44,058 44,058 Long Term Debt m 62,918 62,918 62,918 62,918 Provisions m 307 1,687 3,038 4,609 Other Liabilities m 75,425 75,425 75,425 75,425 Total Liabilities m 271,166 280,008 289,216 296,271 Shareholders' Funds m 289,183 303,632 322,145 345,372 Minority Interests m 925 1,025 1,125 1,225 Other m 0 0 0 0 Total S/H Equity m 290,108 304,657 323,270 346,597 Total Liab & S/H Funds m 561,274 584,665 612,487 642,868

All figures in Rmb unless noted. Source: Company data, Macquarie Research, March 2016

23 March 2016 8 Macquarie Research China Telecom Important disclosures: Recommendation definitions Volatility index definition* Financial definitions Macquarie - Australia/New Zealand This is calculated from the volatility of historical All "Adjusted" data items have had the following Outperform – return >3% in excess of benchmark return price movements. adjustments made: Neutral – return within 3% of benchmark return Added back: goodwill amortisation, provision for Underperform – return >3% below benchmark return Very high–highest risk – Stock should be catastrophe reserves, IFRS derivatives & hedging, expected to move up or down 60–100% in a year IFRS impairments & IFRS interest expense Benchmark return is determined by long term nominal – investors should be aware this stock is highly Excluded: non recurring items, asset revals, property GDP growth plus 12 month forward market dividend speculative. revals, appraisal value uplift, preference dividends & yield minority interests Macquarie – Asia/Europe High – stock should be expected to move up or Outperform – expected return >+10% down at least 40–60% in a year – investors should EPS = adjusted net profit / efpowa* Neutral – expected return from -10% to +10% be aware this stock could be speculative. ROA = adjusted ebit / average total assets Underperform – expected return <-10% ROA Banks/Insurance = adjusted net profit /average Medium – stock should be expected to move up total assets Macquarie – South Africa or down at least 30–40% in a year. ROE = adjusted net profit / average shareholders funds Outperform – expected return >+10% Gross cashflow = adjusted net profit + depreciation Neutral – expected return from -10% to +10% Low–medium – stock should be expected to *equivalent fully paid ordinary weighted average Underperform – expected return <-10% move up or down at least 25–30% in a year. number of shares Macquarie - Canada Outperform – return >5% in excess of benchmark return Low – stock should be expected to move up or All Reported numbers for Australian/NZ listed stocks Neutral – return within 5% of benchmark return down at least 15–25% in a year. are modelled under IFRS (International Financial Underperform – return >5% below benchmark return * Applicable to Asia/Australian/NZ/Canada stocks Reporting Standards). only Macquarie - USA Outperform (Buy) – return >5% in excess of Russell Recommendations – 12 months 3000 index return Note: Quant recommendations may differ from Neutral (Hold) – return within 5% of Russell 3000 index Fundamental Analyst recommendations return Underperform (Sell)– return >5% below Russell 3000 index return

Recommendation proportions – For quarter ending 31 December 2015 AU/NZ Asia RSA USA CA EUR Outperform 50.68% 61.04% 53.16% 47.90% 65.22% 43.59% (for global coverage by Macquarie, 5.33% of stocks followed are investment banking clients) Neutral 31.51% 24.66% 34.18% 47.70% 29.71% 34.62% (for global coverage by Macquarie, 5.02% of stocks followed are investment banking clients) Underperform 17.81% 14.30% 12.66% 4.39% 5.07% 21.79% (for global coverage by Macquarie, 3.78% of stocks followed are investment banking clients)

728 HK vs HSI, & rec history 941 HK vs HSI, & rec history 762 HK vs HSI, & rec history

(all figures in HKD currency unless noted) (all figures in HKD currency unless noted) (all figures in HKD currency unless noted)

Note: Recommendation timeline – if not a continuous line, then there was no Macquarie coverage at the time or there was an embargo period. Source: FactSet, Macquarie Research, March 2016

12-month target price methodology 728 HK: HK$4.30 based on a DCF methodology 941 HK: HK$115.00 based on a DCF methodology 762 HK: HK$14.80 based on a DCF methodology

Company-specific disclosures: 728 HK: Macquarie Capital Limited makes a market in the securities of China Telecom Corp Ltd. 941 HK: Macquarie Capital Limited makes a market in the securities of China Mobile (Hong Kong) Limited. 762 HK: Macquarie Capital Limited makes a market in the securities of China Unicom Ltd. Important disclosure information regarding the subject companies covered in this report is available at www.macquarie.com/research/disclosures.

Date Stock Code (BBG code) Recommendation Target Price 21-Jan-2016 728 HK Outperform HK$4.30 18-Mar-2015 728 HK Outperform HK$5.30 08-Jan-2015 728 HK Outperform HK$5.20 20-Feb-2014 728 HK Outperform HK$4.80 29-May-2013 728 HK Outperform HK$5.10

Target price risk disclosures: 728 HK: Any inability to compete successfully in their markets may harm the business. This could be a result of many factors which may include geographic mix and introduction of improved products or service offerings by competitors. The results of operations may be materially affected by global economic conditions generally, including conditions in financial markets. The company is exposed to market risks, such as changes in interest rates, foreign exchange rates and input prices. From time to time, the company will enter into transactions, including transactions in derivative instruments, to manage certain of these exposures. 941 HK: Any inability to compete successfully in their markets may harm the business. This could be a result of many factors which may include geographic mix and introduction of improved products or service offerings by competitors. The results of operations may be materially affected by global economic conditions generally, including conditions in financial markets. The company is exposed to market risks, such as changes in interest rates, foreign exchange rates and input prices. From time to time, the company will enter into transactions, including transactions in derivative instruments, to manage certain of these exposures. 762 HK: Any inability to compete successfully in their markets may harm the business. This could be a result of many factors which may include geographic mix and introduction of improved products or service offerings by competitors. The results of operations may be materially affected by global 23 March 2016 9 Macquarie Research China Telecom economic conditions generally, including conditions in financial markets. The company is exposed to market risks, such as changes in interest rates, foreign exchange rates and input prices. From time to time, the company will enter into transactions, including transactions in derivative instruments, to manage certain of these exposures.

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23 March 2016 11

Asia Research Head of Equity Research Software and Internet Transport & Infrastructure Peter Redhead (Global – Head) (852) 3922 4836 Wendy Huang (Asia) (852) 3922 3378 Janet Lewis (Asia) (852) 3922 5417 Matt Nacard (Asia – Head) (852) 3922 1362 David Gibson (Asia) (813) 3512 7880 Azita Nazrene (ASEAN) (603) 2059 8980 Hillman Chan (China, Hong Kong) (852) 3922 3716 Corinne Jian (Taiwan) (8862) 2734 7522 Automobiles/Auto Parts Nitin Mohta (India) (9122) 6720 4090 Utilities & Renewables Janet Lewis (China) (852) 3922 5417 Nathan Ramler (Japan) (813) 3512 7875 Zhixuan Lin (China) (8621) 2412 9006 Prem Jearajasingam (Malaysia) (603) 2059 8989 Alan Hon (Hong Kong) (852) 3922 3589 Amit Mishra (India) (9122) 6720 4084 Oil, Gas and Petrochemicals Inderjeetsingh Bhatia (India) (9122) 6720 4087 Lyall Taylor (Indonesia) (6221) 2598 8489 Prem Jearajasingam (Malaysia) (603) 2059 8989 Takuo Katayama (Japan) (813) 3512 7856 James Hubbard (Asia) (852) 3922 1226 Karisa Magpayo (Philippines) (632) 857 0899 James Hong (Korea) (822) 3705 8661 Aditya Suresh (Asia) (852) 3922 1265 Duke Suttikulpanich (ASEAN) (65) 6601 0148 Commodities Banks and Non-Bank Financials Abhishek Agarwal (India) (9122) 6720 4079 Colin Hamilton (Global) (4420) 3037 4061 Matthew Smith (China) (8621) 2412 9022 Polina Diyachkina (Japan) (813) 3512 7886 Ian Roper (65) 6601 0698 Suresh Ganapathy (India) (9122) 6720 4078 Anna Park (Korea) (822) 3705 8669 Jim Lennon (4420) 3037 4271 Lyall Taylor (Indonesia) (6221) 2598 8489 Isaac Chow (Malaysia) (603) 2059 8982 Lynn Zhao (8621) 2412 9035 Keisuke Moriyama (Japan) (813) 3512 7476 Pharmaceuticals and Healthcare Matthew Turner (4420) 3037 4340 Leo Nakada (Japan) (813) 3512 6050 Rakesh Arora (9122) 6720 4093 Chan Hwang (Korea) (822) 3705 8643 Abhishek Singhal (India) (9122) 6720 4086 Gilbert Lopez (Philippines) (632) 857 0892 David Lee (Korea) (822) 3705 8686 Economics Thomas Stoegner (Singapore) (65) 6601 0854 Property Peter Eadon-Clarke (Global) (813) 3512 7850 Dexter Hsu (Taiwan) (8862) 2734 7530 Larry Hu (China, Hong Kong) (852) 3922 3778 Passakorn Linmaneechote (Thailand) (662) 694 7728 Tuck Yin Soong (Asia, Singapore) (65) 6601 0838 Tanvee Gupta Jain (India) (9122) 6720 4355 Conglomerates David Ng (China, Hong Kong) (852) 3922 1291 Kai Tan (China, Hong Kong) (852) 3922 3720 Quantitative / CPG Gilbert Lopez (Philippines) (632) 857 0892 Raymond Liu (China, Hong Kong) (852) 3922 3629 Gurvinder Brar (Global) (4420) 3037 4036 Wilson Ho (China) (852) 3922 3248 Consumer and Gaming Woei Chan (Asia) (852) 3922 1421 Abhishek Bhandari (India) (9122) 6720 4088 Anthony Ng (Asia) (852) 3922 1561 Linda Huang (China, Hong Kong) (852) 3922 4068 William Montgomery (Japan) (813) 3512 7864 Danny Deng (Asia) (852) 3922 4646 Kai Tan (China) (852) 3922 3720 Aiman Mohamad (Malaysia) (603) 2059 8986 Per Gullberg (Asia) (852) 3922 1478 Zibo Chen (Hong Kong) (852) 3922 1130 Kervin Sisayan (Philippines) (632) 857 0893 Amit Mishra (India) (9122) 6720 4084 Corinne Jian (Taiwan) (8862) 2734 7522 Strategy/Country Fransisca Widjaja (Singapore) (65) 6601 0847 Patti Tomaitrichitr (Thailand) (662) 694 7727 Viktor Shvets (Asia, Global) (852) 3922 3883 Hendy Soegiarto (Indonesia) (6221) 2598 8369 Resources / Metals and Mining Chetan Seth (Asia) (852) 3922 4769 Toby Williams (Japan) (813) 3512 7392 Peter Eadon-Clarke (Japan) (813) 3512 7850 HongSuk Na (Korea) (822) 3705 8678 Rakesh Arora (India) (9122) 6720 4093 David Ng (China, Hong Kong) (852) 3922 1291 Karisa Magpayo (Philippines) (632) 857 0899 Stanley Liong (Indonesia) (6221) 2598 8381 Erwin Sanft (China, Hong Kong) (852) 3922 1516 Polina Diyachkina (Japan) (813) 3512 7886 Emerging Leaders Rakesh Arora (India) (9122) 6720 4093 Anna Park (Korea) (822) 3705 8669 Lyall Taylor (Indonesia) (6221) 2598 8489 Jake Lynch (China, Asia) (852) 3922 3583 Technology Chan Hwang (Korea) (822) 3705 8643 Aditya Suresh (Asia) (852) 3922 1265 Gilbert Lopez (Philippines) (632) 857 0892 Neel Sinha (ASEAN) (65) 6601 0562 Damian Thong (Asia, Japan) (813) 3512 7877 Conrad Werner (Singapore) (65) 6601 0182 Timothy Lam (Hong Kong) (852) 3922 1086 Allen Chang (852) 3922 1136 Jeffrey Ohlweiler (Taiwan) (8862) 2734 7512 Mike Allen (Japan) (813) 3512 7859 (China, Hong Kong, Taiwan) Alastair Macdonald (Thailand) (662) 694 7753 Kwang Cho (Korea) (822) 3705 4953 Nitin Mohta (India) (9122) 6720 4090

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