Xinyi released its results for the first half of fiscal year 2020 on Friday. The company's stock price performance in recent March belongs to the market, combined with fundamentals, we think the current valuation is attractive. Investment highlights: 1) the demand for remote work increased during the short-term epidemic, and the original users of the company were further activated; 2) the management area firmly ranked the leader of the Hong Kong data center, the new center will be completed this year, and the load of the original center will be increased. The growth potential is guaranteed; 3) the Ministry of Industry and Information Technology proposes to speed up the construction of 5G and expand network consumption, which will benefit the data center companies at the end of the industry chain in advance. 4) compared with similar companies in US A shares, valuations are attractive; 5) shareholders are strong, dividends are stable, dividends are expected to be maintained in fiscal year 2020, and the current price corresponds to a dividend yield of more than 3 per cent.

Favorable factors

The construction of 5G is expected to be accelerated and will benefit data center suppliers in the long run. The Ministry of Industry and Information Technology held a teleconference on February 22, calling for speeding up the development of 5G, doing a good job in the resumption of work and production in the information and communications industry, and promoting the high-quality development of the information and communications industry. The data center company is located at the back end of the industry chain, and the increase in demand will occur after 5G construction is put into use, when the demand of enterprise customers for information storage increases. We believe that the acceleration of the construction of 5G in China will accelerate the development of the industry as a whole, and the Hong Kong market is expected to benefit. Xinyi is one of the largest data center suppliers in Hong Kong. The flagship data center is recognized as a major network connection hub in Hong Kong. In the future, the company is expected to benefit from the acceleration of 5G development.

Social activities had little impact on the company last year, and the recent epidemic has increased the telecommuting needs of some customers. It is reported that the social activities in 2019 have little impact on the company, the demand of major customers for infrastructure such as data centers continues to expand, and MEGA Plus, the flagship data center in Tseung Kwan O, continues to have new customers. Since the epidemic this year, due to the increased demand for telecommuting from customers, the short-term activity of financial and Internet customers has increased, but retail customers have been affected.

The construction of new projects in Tseung Kwan O and Tsuen Wan continues to move forward, and there is a rich area reserve for future business expansion. Tseung Kwan O flagship data Centre MEGA Plus is the only data centre built on exclusive land in Tseung Kwan O and is not subject to any restrictions on land use (such as sublease). The company is currently working on a new land project, TKOTL 131, adjacent to MEGA Plus, which was acquired in 2018 and is the last piece of high-end data centre land in Hong Kong. The project, which will provide about 1.2 million square feet of floor area, is in the final stage of design and is expected to be completed in 2022. Upon full completion, SUNeNet will occupy a floor area of about 1.7 million square feet in Tseung Kwan O and will become a major data hub in Hong Kong, providing integrated facilities and services with more significant operational and cost synergies. The company is also actively developing the Tsuen Wan new site TWTL 428 data centre project. TWTL428's proximity to the existing data centre facility, JUMBO, will expand approximately 200,000 square feet of floor area for the company's data centre capacity in Tsuen Wan. The TWTL428 project is expected to be completed in 2022.

By consolidating data center assets, the utilization efficiency of existing centers will be improved. In addition to developing new land projects, Xinyi also continues to invest in upgrading existing facilities. MEGA-i, the company's Asian network connection hub, will complete the optimization project by the end of 2020, which will increase power capacity by 40% and achieve higher space use efficiency. The company acquired the MEGA Two property of the data center facility from shareholders in October 2019 in order to further improve the quality of infrastructure and services in the future.

Financial comments: income growth slows in the short term, capital expenditure and loan interest increases, affecting short-term profitability.

(1) the company's revenue increased by 12% to HK $818.6 million during the period, driven by new customer contracts and revenue growth from existing customers. The growth rate has slowed down from 19% last year, mainly due to the higher revenue base last year due to the higher demand for disposable facilities services when customers moved in last year. In the short term in the future, in view of the nature of the company's business as information infrastructure, the impact of the epidemic closure on sales is expected to be short-lived and limited, and MEGA-Plus continues to access new customers, MEGA-i will also complete capacity expansion by the end of the year, and short-term performance will continue to grow steadily. In the medium and long term, Internet companies and cloud manufacturers have strong customer demand and sufficient inventory reserves, and we are optimistic about its growth momentum.

(2) the increase of the cost of sales is equal to that of revenue, and the gross profit margin is basically the same as that of the same period last year, maintaining at about 56%. The operating expenditure increased during the period, and the operating profit margin decreased by 1.58 percentage points to 48.99% compared with the same period last year, mainly due to the increase in sales and management costs, the proportion of the two expenses in income increased from 6.62% to 7.94%, and the legal costs arising from the judicial review of the Tseung Kwan O Industrial Estate project. The increase in sales and administrative expenses is mainly used to improve the enthusiasm of employees. Profit from continuing operations rose 7.1 per cent to HK $321 million, with a net interest rate of 39.2 per cent, down slightly from 41.11 per cent in the same period last year, and interest payments increased.

(3) the increase in corporate bank loans was mainly due to the upgrading of facilities and working capital requirements, with the current financial cost rising to HK $20.4 million. As of December 31, 2019, the company held approximately HK $488.5 million in cash, bank loans and shareholder loans of HK $5.8287 billion and HK $3.3 billion respectively. The shareholder loan comes from a six-year unsecured term loan provided by Sun Hung Kai Properties Group (73.9%). Total loans increased by HK $1.076 billion to HK $9.1287 billion during the period. the new loans were mainly used to cover capital expenditure on data centre facilities optimization projects and to pay the net consideration of related transactions (acquisition of MEGA Two). On December 31, 2019, the company's debt ratio was 220%; excluding long-term unsecured shareholder loans, the debt ratio was 136% (103% in the previous period). In December 2019, the company obtained a long-term unsecured bank financing of HK $3 billion for short-term bank loan refinancing and business development. We believe that Sun Hung Kai, the company's major shareholder, is strong, the company has good assets and a good relationship with banks, which is sufficient to meet the future financing needs of Xinyi.

(4) dividend: although investment is required for the construction and operation of new projects, taking into account the strong shareholder background of the company and the driving force of continued business growth, we expect the absolute value of the dividend in fiscal year 2020 to be not less than that in fiscal year 2019 (HK $61 billion). Based on a dividend of HK16.5 cents per share last year, the contract has a dividend yield of 3.2% based on the closing price of HK $5.13 on February 25.

Valuation conclusion: downgrade short-term profit forecast, target price 6.57 Hong Kong dollars, optimistic about future data center capacity release and long-term stable dividend. We are optimistic about the steady growth of the company's performance, because on the demand side, 5G construction is accelerated and the demand of cloud service manufacturers continues to be strong; on the supply side, the company's future data center area is rich in supply reserves. excellent service quality and word-of-mouth make Xinyi a strong competitor in the Hong Kong market.

Due to lower-than-expected revenue growth in the first half of the year, we lowered our revenue forecast for fiscal year 2019, raised our expense estimates, and obtained a target price of HK $6.57 using the discounted cash flow method. Compared with US A-share peer companies, the company's static price-to-earnings ratio / price-to-sales ratio is 13.8 times earnings / price-to-sales ratio respectively, and the industry average price-to-earnings ratio / price-to-sales ratio is about 57 times earnings / 8.38 times, indicating that the company is the target of strong profitability and low valuation. the gross profit margin and net profit margin of the company in the last fiscal year were 57.2% and 43.3% respectively, significantly higher than the industry average of 33.6% and 10.55%. And the company's major shareholders are strong, Xinyi net has the ability to maintain long-term stable dividend. Risk factors: rising sales and management costs; high debt ratio, increased loans to increase interest payments; short-term impact on profitability; slower-than-expected arrival of new customers; and slower-than-expected growth in demand for cloud services in Hong Kong.