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I continue to rate SK Telecom Co., Ltd.'s (NYSE:SKM) [017670:KS] shares as a Buy. I have observed positive signs relating to SKM's core mobile telecommunications business and the company's AI-related growth initiatives. SK Telecom's current valuation metrics indicate that the company's shares have meaningful upside potential.
With my prior July 4, 2024, update, I highlighted that SKM is a leading telecommunications company in terms of "mobile segment market share" and "AI competitiveness."
SKM's most recent quarterly financial performance was good thanks to the improvement in the profitability of its core mobile telecommunications business.
Operating profit for SK Telecom rose by +16% YoY and +8% QoQ to KRW 538 billion in the second quarter of this year, as disclosed in its results presentation slides. SKM's actual Q2 2024 operating income represented a 4% beat according to consensus data sourced from S&P Capital IQ.
The core mobile or wireless telecommunications business contributed 84% of SKM's Q2 2024 operating income. The company derived the remaining 16% of its second quarter operating profit from pay television, fixed line services, and other B2B (Business-To-Business) businesses. The performance of SK Telecom's core mobile telecommunications business has the biggest influence on the company's overall results in the near term because SKM's wireless services accounted for the vast majority of its operating profit.
The operating margin for SK Telecom's mobile telecommunications business expanded by +1.9 percentage points YoY from 12.2% in Q2 2023 to 14.1% for Q2 2024. This was the key factor driving SKM's latest Q2 2024 operating profit beat.
SKM shared at its Q2 2024 analyst briefing that it has implemented initiatives to "sell high ARPU (Average Revenue Per User) price plans and attract high tier subscribers. The company also indicated at its recent quarterly results briefing that "the (Korean) telecommunications firms are no longer competing on subsidies, but rather competing 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 enabled SK Telecom to market its premium wireless subscription packages. Notably, 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 has achieved "cost stabilization" due to "efforts to improve operating efficiency." In specific terms, SKM's marketing and depreciation costs declined by -4% YoY to KRW 1,406 billion for the latest quarter.
Looking ahead, I take the view that SKM is likely to register favorable financial results for full-year FY 2024.
One positive factor is that the Korean mobile market is already past the phase of players competing aggressively for 5G subscribers. Over 70% of SKM's mobile subscribers are on 5G wireless plans as of end-Q2 2024, which implies that the 5G penetration level is reasonably high in South Korea. Therefore, SK Telecom and its rivals are most probably going to place a greater emphasis on monetizing existing 5G subscribers than cutting prices to attract new ones.
The other positive factor is that SK Telecom has the intention to continue with expense control and profit margin enhancement initiatives for the foreseeable future. At its Q2 analyst call, SKM emphasized that it is "committed to improving the business fundamentals of the fixed and mobile businesses through OpEx (operating expense) and CapEx (capital expenditures) efficiency" optimization measures.
I am anticipating a low-teens percentage growth in SK Telecom's operating profit for full-year FY 2024. In contrast, SKM expanded its operating income by a relatively more modest +9% to KRW 1,753 billion in the prior fiscal year or FY 2023. My positive expectations of operating profit growth acceleration for SKM this year is supported by the improvement in competitive dynamics for Korea's wireless market and the company's intention to optimize costs and capital investments.
The operating margin expansion of SKM's mobile telecommunications business will be the key short-term financial performance improvement driver for the company in the near term. For the intermediate to long term, SK Telecom's AI-related offerings will be the major growth engine.
Recent developments suggest that it is just a matter of time before SK Telecom delivers on its AI growth initiatives.
Firstly, SK Telecom's revenue generated by its data center business and cloud services business increased strongly by +21% and +28%, respectively in Q2 2024. At the company's Q2 2024 results briefing, SKM attributed the robust growth for its data center business to "AI-driven demand" and it disclosed that its cloud services business "successfully won the first order for AI cloud" in the latest quarter.
Secondly, SKM guided for incremental AI-related revenue contribution of KRW 60 billion this year relating to the offering of "generative AI, AICC (AI Call Center) and AI data advertising solutions to the financial and the manufacturing sectors" as per its Q2 earnings call commentary. This serves as an example of how SK Telecom is exploring the provision of new B2B (Business-To-Business) AI offerings targeted at specific industries.
Thirdly, the company's B2C (Business-To-Consumer) AI product known as "A Dot" has continued to gain meaningful traction. In late September last year, SK Telecom revealed "the official launch of" A Dot, which it described as a "personal AI assistant service." An earlier 2023 CNBC news article also referred to A Dot as SKM's "artificial intelligence chatbot." As disclosed in SKM's Q2 2024 results presentation, the A Dot subscriber base grew by +155% to 4.6 million at the end of June this year, or nine months following its official introduction to the market. 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 highlighted that SKM's "AI competitiveness" will support its goal to grow "the percentage of sales contributed by the company's AI-related services and products from below 10% now to 36% by FY 2028." The latest AI-related developments for SK Telecom mentioned above have boosted my confidence in the growth prospects of the company's AI-related businesses.
There are specific risks to watch with respect to SKM.
SK Telecom's core mobile telecommunications business could perform badly in the scenario that this business fails to manage costs well and the competitive intensity in the Korean mobile services market rises.
SKM's future AI revenue growth outlook might be more modest, assuming that AI-related demand weakens going forward.
There are positive read-throughs from the recent performance of SKM's mobile telecommunications 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 this is why I have retained my Buy rating on the stock.
Based on S&P Capital IQ data, SK Telecom currently trades at 4 times consensus next twelve months' EV/EBITDA and offers a consensus next twelve months' dividend yield of 6%. A valuation rule of thumb 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% as per S&P Capital IQ, which implies that a high-single digit EV/EBITDA ratio for the stock won't be unreasonable. Also, SK Telecom's dividend yield could potentially compress to a low-to-mid single digit percentage in the future, when investors have a better appreciation of the company's mid-to-long term growth prospects driven by AI.