Incidents:

The company released its annual report for '22 and its quarterly report for '23. It achieved revenue of 2,040 million yuan, down 4% year on year, net profit of 850 million yuan, down 14% year on year, after deducting non-net profit of 1.02 billion yuan, down 3.5% year on year. The year-on-year deduction performance was stable year over year, in line with market expectations.

The company achieved revenue of 501 million in 1Q23, down 13% year on year, net profit of 240 million yuan, down 10% year on year. Q1 performance exceeded market expectations (expected profit fell 40-50%), exceeding expectations due to joint venture investment income and “The Original Journey”

Reasons such as the fact that it is better to start production.

Key points of investment:

Core new products performed brilliantly, and the visibility of growth increased further in '23. The company's Q1 revenue side declined year over year, mainly because “Ball Ball” Q1 was under pressure from last year's high base, while the month-on-month increase came from “The Original Journey”, which went live on 3.24, which contributed to Q1. Since its launch, “The Original Journey” has exceeded expectations, with sales exceeding 300 million yuan in the first month, better than the previous market expectations of 1-2 billion yuan, and its addition, retention, and recycling conditions are good. Currently, it is still in the top 20 iOS bestsellers list, which is expected to be an important increase for the company this year, driving the company's growth visibility throughout the year. Judging from subsequent product reserves, “Unremitting Urara”

The two-dimensional RPG “Dragon and the End of the World” developed by producer Liu Yifeng is expected to be launched in the summer, and the space werewolf killing product “Space Ops”, which was launched at the beginning of the year, will also be promoted and commercialized in the summer. The two products are expected to establish certainty for growth from the second half of the year to next year.

New products led to an increase in sales expenses, and gross margin picked up month-on-month. The Q1 sales expenses rate increased by 24 pct to 38.7% year on year. Mainly due to the low cost rate of promotion of old products and the high purchase volume of the newly launched “Original Journey”, we expect the high level of sales expenses to continue to be maintained, supporting the continued launch of “The Original Journey” and the promotion of new products in the second half of the year. Q1 gross margin increased 10pct to 87% month-on-month, showing a significant recovery.

Actively embrace AI, and the relevant layout is already underway. Founder Shi Yuzhu attaches great importance to AI. He has now formed an AI team to promote the implementation of AIGC tools in various business scenarios throughout the company; strengthening external cooperation and exploring AI+ game solutions, including the UGC+AI direction of “Battle Ball”, the intelligent NPC direction of MMO such as Journey Journey, etc., and collaboration with Baidu Wenxin is all being explored and laid out.

Adjust profit forecasts to maintain the “buy” rating. Considering that Q1 exceeded expectations and the strong performance of “The Original Journey”, while carefully considering the decline in the flow of old products in 24 and the upward trend in profit margins, we adjusted the 23-24 revenue forecast to 31.6/3.89 billion (the original forecast was 31.400.3 billion), adding 4.28 billion to the 25-year forecast; the adjusted net profit forecast for 23-24 was 1.30/1.59 billion (the original forecast was 1,25/1.56 billion), adding 1.74 billion yuan to the 25-year forecast. The current price corresponds to 23-25 PE 24/20/18x. We expect the company to enter an inflection point in its performance in Q2, and the AI layout is more resilient to positive valuations and maintain the “buy” rating.

Risk warning: There is a risk of marginal changes in regulatory policies, delayed/performance of game projects falling short of expectations, and long-term operation falling short of expectations.