OREANDA-NEWS. Fitch Ratings has affirmed China Telecom Corporation Limited's (CTCL) Long-Term Foreign-Currency and Local-Currency Issuer Default Rating (IDR) at 'A+' with Stable Outlook.

KEY RATING DRIVERS

Strong Government Support: The ratings benefit from the strong state support and CTCL's strategic importance to the Chinese sovereign (A+/Stable) - the company's ultimate majority owner. CTCL is 71%-owned by China Telecommunications Corporation (CTC), which is 100%-owned by the State-owned Assets Supervision and Administration Commission. The state owns 82.85% of CTCL when all state shareholders are included.

Dominant Fixed-line Market Position: The ratings reflect CTCL's dominant status in southern China for fixed-line and broadband services, which enables the company to continue to offer bundled services and differentiated information, content and technology (ICT) services and value-added services (VAS). Resilient fixed-line revenue and further cuts in CTCL's fixed-line and broadband capex in 2015 are likely to result in solid fixed-line free cash flow (FCF), which would help fund CTCL's mobile capex.

Solid Mobile Execution: The ratings also reflect CTCL's solid execution ability in its mobile business, despite disadvantages of the code division multiple access (CDMA) technology and the delayed licensing of frequency division duplex-long term evolution (FDD LTE) networks. CTCL has been utilising its low cost, wide coverage and high quality CDMA network to expand market share and drive mobile data revenue growth. We expect the FDD LTE service rollout and the forthcoming tower sharing to enable CTCL to further gain mobile market share.

VAT Reform Burden: The ratings also take into consideration of the full-year impact on EBITDA of the value-added tax (VAT) reform, which was implemented in June 2014. However, Fitch believes that the impact of the VAT reform is likely to be short-lived. As VAT is implemented in more industries, CTCL's profitability should recover due to an expected increase in input VAT credits. Also, we expect that CTCL will transform its revenue mix, raising VAS to reduce output VAT liabilities.

Higher Capex: The ratings also reflect our expectations that CTCL's capex will remain high in the next two-three years, driven by 4G network rollout. CTCL has already raised its 2015 capex budget by 40% to CNY108bn, following the FDD LTE licensing in February 2015. CTCL plans to step up 4G investment to achieve 320,000 4G base stations and 140,000 indoor radio distribution systems by end-2015. With higher capex, we expect CTCL's pre-dividend FCF to turn negative in both 2015 and 2016, but turn positive from 2017.

Tower Sharing: The ratings also reflect our expectations that the Chinese government's tower sharing initiative is unlikely to materially alter CTCL's credit profile. We believe tower sharing will enable CTCL and China Unicom (Hong Kong) Limited to gain access to China Mobile Limited's (CML; A+/Stable) network resources and improve their network quality and coverage as well as save capex over the long term. However, tower sharing will result in higher adjusted net leverage and the transfer of CTCL's tower assets to the national tower company will be a non-cash transaction.

Low Leverage: Fitch expects CTCL's funds flow from operations (FFO)-adjusted net leverage ratio to stay below 2x in the next two to three years, even considering higher 4G capex and the capitalisation of tower leasing fees as off-balance sheet debt. CTCL has a low leverage with net debt/EBITDA of 0.9x in 2014. We estimate that FFO-adjusted net leverage in 2014 could have remained at 1.4x.

Adequate Liquidity: Fitch believes that CTCL will maintain adequate liquidity. CTCL's unrestricted cash position amounted to CNY22bn at end-2014. Debt due within one year totalled CNY44bn at end-2014. However, CTCL has strong support from its state-owned parent, CTC, and Chinese banks. At end-2014, unutilised committed credit facilities were CNY130bn. About 58% of its CNY107bn total debt was due to its parent.

KEY ASSUMPTIONS

Fitch's key assumptions within our rating case for the issuer include:
- mobile subscriber net additions to resume in 2015 and 2016
- average revenue per user (ARPU) to remain stable due to stronger data revenue growth
- EBITDA margins at about 30% in two to three years
- capex of CNY100bn-110bn in 2015 and 2016
- dividend payment at about CNY6bn for each of 2015 and 2016

RATING SENSITIVITIES

Negative: Future developments that may, individually or collectively, lead to negative rating actions include
- FFO-adjusted net leverage above 2x on a sustained basis
- EBITDAR margin below 30% on a sustained basis (2013: 31.9%)
- weakening in linkages with the state, which is not envisaged in the foreseeable future

Positive: Due to CTCL's smaller mobile market share relative to its major competitors', as well as its likely lower profitability and higher capex, a rating upgrade is unlikely in the medium term.