Hometown Interactive (03798.HK)'s total revenue for fiscal year 2022 increased by 37.0% year-on-year to 1.56 billion yuan, but its gross margin and net profit margin fell to 65.3% and 29.8%, respectively. The net profit margin for the year decreased 6.9% year-on-year, lower than our expectations. The Group announced a final dividend of HK$0.14 per share, equivalent to a distribution ratio of approximately 50% for the whole year.

More careful spending budgets are needed: Hometown Interactive (03798.HK) operating cost ratio rose to 48.9% in fiscal year 2022, mainly due to i) increased spending on offline marketing activities including competition sponsorships, ii) increased marketing spending on short video platforms, and iii) team expansion. We are paying close attention to the direction and strength of the Group's future cost control and the marginal benefits of customer acquisition in various marketing activities. At the same time, we acknowledge that the Group needs a more careful online marketing budget to maintain its profit level. In particular, the Group needs to invest extra money for “Meet Meeks” this year.

The decline in gross margin could not be reversed: the channel cost of Hometown Interactive (03798.HK) in fiscal year 2022 increased 113.8% over the same period last year to RMB 4.2 billion, mainly due to the increase in the distribution share of third party platforms such as Tencent, short video platforms, and smartphone manufacturers. We approve that the Group's gross margin is falling faster than we anticipated, but due to the huge number of users of third-party platforms, the drainage effect is excellent. It is a reasonable and predictable trend that the distribution share of third-party platforms continues to rise, so the Group's gross margin is likely to remain at the current low level.

A sound core business can withstand short-term adverse factors: as mentioned in our previous research reports, we believe that Hometown Interactive (03798.HK) has sufficient resources and that the group is sufficient to ease off various tests, including adopting new marketing strategies and developing new businesses. We believe that the adverse factors currently facing the Group are of a temporary nature and have no significant adverse impact on the Group's cash generation operations, asset quality, and attractive dividend policies (the current dividend rate is about 8.6%). We need more evidence (such as significant relaxation of growth/deterioration in asset quality, etc.) to change our current position. At the same time, the Chinese mahjong industry released a positive signal. At the end of 2022, the International Mahjong Federation and the Hangzhou Branch of the Chinese Chess Academy jointly set up the Mahjong Athletic Skills Grading Assessment Center. At the same time, they published the “Mahjong Athletic Skills Grading Management Act” and “Implementation Opinions on Promoting Standardized Construction of the Mahjong Tournament System” and characterized the mahjong game as a professional sports competition. Therefore, in the long run, we still have a positive attitude towards the Group's development prospects, but in the short term, we agree that the Group needs to make appropriate adjustments, so we lowered our profit forecast by 16.8% - 26.7%, and cut the Group's target price to HK$2.27 per share, and downgraded the rating to buy.

Risk Factors

Controlling the negative impact of marketing costs on customer acquisition

Marketing costs reduce group profitability

Failure to maintain a stable dividend distribution policy

The repositioning of mahjong games in the Chinese region failed to bring about a fundamental change

Peers have drastically increased marketing investment to bring direct competition to the group

Indirect competition from other online games

Overseas development and game development business are progressing slower than expected