Goodwill impairment and fixed asset impairment dragged down 2019 performance below our expectations, and Tongding Internet released its 2019 annual report. In 2019, the company achieved revenue of 3,539 billion yuan, a year-on-year decline of 20%, lower than our previous forecast of 4%; net profit loss for the whole year was 2,123 million yuan (profit of 565 million yuan in 2018), dragged down by factors such as impairment of goodwill and impairment of fixed assets, which was significantly lower than the previous forecast of 220 million yuan. 4Q19 achieved revenue of 665 million yuan, down 40% from the previous year, and recorded a net profit loss of 2,207 million yuan in the single quarter.
Development trends
The company's 2019 performance was significantly lower than our previous expectations, mainly because: 1) Optical fiber cable gross margin was lower than expected: We had anticipated a drag on revenue caused by the decline in the boom in the fiber and cable industry, but the sector's gross margin was 9.2ppt lower than our previous expectations. 2) The overall Internet security (Baizhuo Network) business fell short of expectations, mainly affected by the reduction in customer investment scale, backward investment time, and increased industry competition. The sector's revenue fell 73% below expectations, and gross margin was lower than expected 27.7ppt. 3) Calculating one-time asset impairment losses: the production capacity utilization rate of optical bar equipment was low, causing fixed assets such as Tongding Light Bar to be reduced by 380 million yuan; the price reduction of inventory products was prepared for 290 million yuan; it was confirmed that Baizhuo Network's goodwill impairment loss of 860 million yuan and Rui Wing Information's goodwill impairment loss of 0.6 billion yuan, totaling 920 million yuan.
4) Revenue declined but expenses increased year-on-year: Sales expenses and management expenses increased 25% and 72% year-on-year due to factors such as increased wages for transportation and cybersecurity sales staff and depreciation of fixed assets.
The recovery in industry demand in 2020 is expected to drive marginal improvement in the fiber optic cable sector. We expect domestic fiber demand to grow 21% in 2020 as 5G base stations begin to be built and the overseas FTTH market expands. 4Q18 Tongding's four light rod production lines reached production, resulting in an annual production capacity of 600 tons of light bars, but in 2019, the capacity utilization rate of light bars was only 14.11%, which dragged down the sector's profit performance. We expect that as industry demand recovers, the company's capacity utilization rate is expected to increase, leading to a recovery in sector revenue and gross profit. At the same time, the company announced that Suzhou Wuqi Innovation increased the capital of Tongding Guangbang, a wholly-owned subsidiary, by 500 million yuan, and that Tongding Guangbang's capital strength was strengthened.
We expect that in 2020, with the development of new infrastructure policies and 5G construction, the company's communication cable, power cable, and communication equipment business is expected to achieve steady growth, which will support the overall performance. Furthermore, we expect orders from the Baizhuo Cyber Security Center to be fulfilled within the year; in 2019, Ruizhuo Information achieved a 236%/299% year-on-year increase in finance/game marketing revenue. We expect business growth to slow down due to the impact of the pandemic, but it is still expected to achieve steady growth.
Profit forecasting and valuation
The company previously announced that 1Q20 expects a loss of 45 million yuan to 55 million yuan; considering the impact of the epidemic and the year-on-year decline in fiber and cable prices throughout the year, we lowered the 2020 profit forecast by 63% to 120 million yuan, while introducing the 2021 profit forecast to 316 million yuan. The current stock price corresponds to the 2020/2021 price-earnings ratio of 58.2 times/22.1 times. We maintain our neutral rating and lowered the target price by 19.7% to 6.26 yuan based on 25x P/E in 2021, corresponding to a price-earnings ratio of 25 times in 2021 and an upward margin of 13.4%.
risks
The driving effect of 5G construction on optical fiber cables is lower than expected; precision marketing business has been hampered by the epidemic.
