1H23 performance fell short of our expectations
Starnet Ruijie announced its 2023 annual report: 1H23 achieved operating income of 6.970 billion yuan, an increase of 4.09%; net profit of 198 million yuan, a year-on-year decrease of 36.37%; net profit of 38 million yuan after deducting non-return net profit of 138 million yuan, a year-on-year decrease of 51.94%. Corresponding to the 2Q23 single quarter, the company achieved operating income of 3.617 billion yuan, a year-on-year decrease of 3.42%, an increase of 7.88%; net profit attribution was 117 million yuan, a year-on-year decrease of 39.43%, lower than our expectations. We determined that it was mainly due to the company's increase in R&D investment, labor, etc., and sales expenses to match the increase in business scale. The 2Q23 sales/management/R&D expense ratio increased 2.9ppt/0.7ppt/4.0ppt to 13.7%/4.8%/17.1%, respectively; net profit not attributable to the same period 65 million yuan, a year-on-year decrease of 65.43%.
Development trends
The overall growth rate of enterprise-grade network equipment is slowing down, and the operator switch market is developing well. 1H23's enterprise-level network equipment achieved revenue of 4.485 billion yuan, an increase of 10.29% over the previous year. The growth rate slowed due to demand from the Internet, government and enterprises; gross margin increased by 1.51 ppt to 42.26% year on year. We believe it is mainly due to product structure optimization and the continuous increase in the share of high value-added products. Specifically, as for the subsidiary Ruijie Network, 1H23 Ruijie Network achieved revenue of 4.831 billion yuan, an increase of 6.82% over the previous year. According to IDC, 1Q23 Ruijie Network ranked third in China's Ethernet switch market share, and the market share of data center switches among domestic operators increased from 17.3% in 1Q22 to 24.2%. We believe that operators' resource bias on capital expenditure on computing power networks is expected to continue to drive demand for cloud network hardware procurement.
Revenue from smart communication products is under pressure, and the subsidiary Starnet Intelligence has shown its performance resilience. Affected by macroeconomic austerity, 1H23's communications products business revenue fell 2.29% year on year to 1,162 billion yuan; gross margin fell 3.49 ppt to 17.09% year on year, and the sector's overall profitability was under pressure. Specifically, as for the subsidiary Starnet Intelligence, the company innovates smart solutions around various application scenarios. 1H23 achieved revenue of 937 million yuan, an increase of 10.10% over the previous year.
Continuously increase R&D investment; inventory levels fall. The company adheres to an innovation-driven development strategy and continues to increase R&D investment. In 2Q23, the company's R&D expenses increased 26% year-on-year, and its revenue share reached 17.1%. The same and month-on-month increases were 4ppt and 1ppt respectively. In terms of inventory, by the end of June 2023, the company's inventory amount had dropped to 4.01 billion yuan, and the inventory level had decreased; turnover capacity had improved, and the number of inventory turnover days had dropped to 178.8 days, an improvement of 17.4 days over the same period last year.
Profit forecasting and valuation
Considering that the company's R&D and management expenses have increased beyond our previous expectations, that downstream Internet demand has fluctuated in the short-term, and that government and enterprise customer demand has not yet recovered, we lowered our 2023/24 profit forecast by 25%/23% to 530.684 million yuan. The current stock price corresponds to 20.0/15.5 times P/E in 2023/24. Maintaining an outperforming industry rating, taking into account the downgrade in performance and the central level of industry valuation, we downgraded the target price by 18% to 20.5 yuan based on 23 times P/E in 2023, which is 15% upward from the current stock price.
risks
Purchases in the domestic telecom and digital communication market fell short of expectations; the recovery in customer demand in the government and enterprise industry fell short of expectations.