Morgan Stanley downgraded the rating of Chinese telecom stocks to "Neutral" as the driving factors of the rising cycle over the past few years have ended

Morgan Stanley published a report stating that the "peak" value of the Greater China telecom operators has largely passed, thus downgrading the industry rating from "Attractive" to "Neutral" (In-Line). The outlook for internet data centers remains strong, with potential easing on the supply side in the future.

According to the bank's economic team forecast, mainland China will continue to face deflation in 2026, with ten-year government bond yields bottoming out and the renminbi strengthening. The U.S. is expected to further cut interest rates in the first half of 2026, leading the bank to downgrade the rating of Greater China telecom operators to "Neutral."

The bank indicated that the driving factors behind the years of rising cycles for Chinese telecom operators—such as regulatory easing, reduced competition, increased cloud business share, and fundamentals of shareholder returns—have passed. The macro environment and ongoing deflationary pressures are impacting mobile business, while artificial intelligence is not yet sufficient to drive revenue growth. The bank downgraded the rating of Chinese telecom stocks H shares to "Equal Weight" (EW), preferring fixed-line over mobile, and favoring H shares over A shares due to the strengthening renminbi and the potential narrowing of A share premiums.

Morgan Stanley pointed out that the weak macro environment and deflationary pattern in mainland China are major obstacles to traditional telecom ARPU growth, and the emphasis on company profits and cash flow may suppress the growth of new business revenues. This situation was already validated in 2025 and is expected to show a similar trend in 2026. Although DeepSeek emerged in the first quarter of 2025, the bank believes that the limited revenue scale and slow adoption by the government sector will restrict the upward potential of Chinese telecom operators' revenues. The bank forecasts that industry service revenue will grow by 1.7% in 2026 (slightly higher than 0.9% in 2025), with total net profit increasing by 3%, mainly driven by efficiency improvements. The bank believes that the adoption of AI by state-owned enterprises/government could become a potential upward catalyst for the three major telecom operators (China Mobile (00941.HK), China Telecom (00728.HK), and China Unicom (00762.HK)).

The bank noted that there are limited drivers for the revaluation of Chinese telecom stocks: (1) Chinese yields are unlikely to decline further; (2) growth is significantly slowing to low single-digit profit growth, and the space for increasing dividend payout ratios is also narrowing. The bank expects the target dividend yield for Chinese telecom H shares to be 6-7% in 2026 and continues to prefer the ranking: China Telecom > China Unicom > China Mobile