OREANDA-NEWS. Fitch Ratings has affirmed South Korea-based KT Corporation's (KT) Long-Term Foreign - and Local-Currency Issuer Default Ratings (IDRs) as well as its senior unsecured rating at 'A-'. The Outlook is Stable.

KEY RATING DRIVERS

Stabilising Margin: Fitch expects KT's margins to continue to benefit from lower marketing and selling, general and administrative costs following a restructuring to streamline its business and labour force. Contraction in fixed-line voice revenue is likely to be offset by solid growth in the internet-protocol television (IPTV) and media businesses. Core-telecom operating EBITDAR margin (as a percentage of service revenue) was 29.6% in 2015, a substantial improvement from 2014's 20.3%, when the margin was affected by intense competition and one-off labour costs.

Stronger Balance Sheet: Fitch expects KT's leverage to remain at a healthy level in 2016, with higher operating cash flows and moderate capex, and its gross debt to reduce further in 2016 from KRW8.8trn in 2015 due to sizeable free cash flow. We forecast core-telecom adjusted net debt/operating EBITDAR to remain at 1.6x-1.7x in 2016-2018 (2015:1.7x).

Slowing Mobile ARPU Growth: Fitch forecasts KT's mobile average revenue per user (ARPU) to continue to rise but at a slower rate as the company's long-term evolution (LTE) subscribers already accounted for 80% of total mobile subscribers in 2Q16. ARPU continued to increase to KRW36,527/month in 2Q16, from KRW36,060/month a year earlier. Fitch expects KT's LTE penetration rate to increase further to 85% by end-2016, which will limit the upside for wireless ARPU over the medium term.

Fixed-Line Revenue to Decline: Fitch expects KT's fixed-line voice revenue and ARPU to continue to decline due to increasing substitution of wireless services for fixed-voice service. In addition, price discounts from bundling and migration to a cheaper voice-over-internet-protocol (VoIP) service will also erode profitability; this trend is unlikely to reverse.

Growing Broadband and Media: The decline in KT's traditional fixed-line telephony service is increasingly offset by its growing broadband and media businesses. Broadband revenue is likely to increase as more subscribers convert to expensive high-speed internet service. We expect the number of IPTV subscribers to continue to grow, reflecting KT's dominant market share in the broadband market (2015: 49.2%). Revenue from pay-per view television, home shopping and advertising should also rise in tandem with the increasing IPTV market share.

Vulnerable to Regulatory Change: KT's credit profile will remain vulnerable to any changes in the regulatory environment, although we expect this to remain stable in the next 12 months. However, uncertainty is rising over regulatory issues, especially as the Handset Distribution Reform Act expires in October 2017, three years after its introduction. The end of the act, which imposed a cap on overall subsidies by wireless telecom operators, may affect KT's long-term profitability because price competition among the operators may reignite.

KEY ASSUMPTIONS

Fitch's key assumptions within our rating case for the issuer include:

- Core-telecom revenue to increase by low single digit percentage in 2016 as growing wireless, broadband and media (IPTV) revenue offsets the decline in fixed-line voice revenue

- Core-telecom EBITDAR margin in 2016 to be similar to the 2015 level with effective cost control

- Capex to fall to around KRW3.2trn (cash basis) in 2016 (2015: KRW3.5trn)

- Free cash flow to remain positive in 2016

RATING SENSITIVITIES

Positive: Future developments that may, individually or collectively, lead to positive rating action include:

- Core-telecom adjusted net debt/ operating EBITDAR below 1.5x

- Core-telecom adjusted net debt/operating EBITDAR (including handset receivables securitisation) below 2.0x (2015:2.2x)

- No sustained decline in absolute level of core-telecom operating EBITDAR

- Sustained positive pre-dividend free cash flow

Negative: Future developments that may, individually or collectively, lead to negative rating action include:

- Core-telecom adjusted net debt/ operating EBITDAR above 2.0x

- Core-telecom adjusted net debt/ operating EBITDAR (including handset receivables securitisation) above 3.0x

- Sustained decline in absolute level of core-telecom operating EBITDAR

- Sustained negative pre-dividend free cash flow