Incident: China's Ruyi (0136.HK) announced its 2023 results. The company achieved operating income of 3.63 billion yuan in 2023, an increase of 175% over the previous year; adjusted profit was 970 million yuan, an increase of 276% year on year, and both revenue and profit performance increased significantly. The company's gross margin in 2023 was 32%, up 12.2pct year over year. By sector, in 2023, the company's content production, online streaming and advertising marketing, and online game service businesses achieved revenue of 22.2/9.3/ 450 million yuan respectively, a year-on-year change of +2001%/-16%/703%. The development potential of various business segments is highlighted.

Content production: The film market environment is gradually recovering, and the company is deeply involved in high-quality content. In 2023, the company's film and television production business segment's revenue reached 2,219 billion yuan, a significant increase compared with 2022. It was mainly due to the recovery of the film market and the company's high-quality projects unleashed performance elasticity. 1) In terms of the movie market, audience enthusiasm for watching movies continues to rise. In 2023, both the box office and number of movie viewers in China achieved significant growth. The total annual box office reached 54.915 billion yuan, and the number of movie viewers reached 1,299 billion, a record high in the past four years. According to Cat's Eye data, as of March 29, 2024, the national film market had grossed 16.209 billion yuan, surpassing 15.857 billion yuan in the first quarter of 2023. 2) In terms of company projects, there is a stable supply of high-quality content. In 2023, the number of films produced and distributed by the company increased significantly over the same period last year, achieving a total box office of RMB 7.554 billion. Among them, the main films controlled by the company include “Enthusiasm”, “Exchanging Lives”, and “Keep You Safe”, etc., which achieved box office of 9.13/ 393/70 million yuan respectively; it co-produced high-quality projects such as “The Girl Who Disappeared”, “Can't Stop the Annual Meeting”, and “King of the Sky”, which achieved box office of 35.24/ 12.92/850 million yuan respectively. During the 2024 Spring Festival, the company participated in the total box office of the four movies “Article 20,” “Hot and Hot,” “Speeding Life 2,” and “Reversing Time and Space”, which the company participated in, grossed over 11 billion yuan. The company's follow-up reserve projects include films such as “Reinforcements Arrive Tomorrow” (Liu Heping as chief producer, war film), “White Snake: Floating” (co-produced by Chasing Light Animation), and “Retrograde Life” (directed by Xu Zheng). We believe that with the restoration of the market environment, the company's advantages in content production will become prominent, and the number and abundance of high-quality projects will increase or provide strong support for the company's performance improvement.

Online games: Jingxiu's game business is rapidly expanding, and game project reserves are abundant or contributing to flexible performance. In 2023, revenue from the online gaming service business was RMB 446 million, an increase of 703% compared with revenue in '22. 1) On the industry side, the overall industry is gradually recovering and rising steadily. According to data from the December 2023 Game Industry Annual Conference, the game industry's revenue in 2023 exceeded 300 billion yuan for the first time, and the number of users reached a record high of 660 million yuan. Meanwhile, the industry environment continues to improve, and the approval of the 2023 game version is stabilizing. 2) In terms of products, Tencent's support is gradually increasing, and Civilized IP mobile games will be launched within the year. According to Qimai data, “Chasing Deer in the Troubled World” and “Legendary World”, which were launched by the company in 2022, are expected to achieve revenue of more than $200/300,000 respectively in 2023. “Ragnarok: Love at First Sight” went live on March 26, 2024. The estimated number of iOS downloads on the first day was 228,000, and the estimated revenue for the first week was $1.95 million. The 4 games the company expects to launch later in 2024 include the SLG product “World Qiyuan” (Civilized IP), the strategic mobile games “Battlefield” and “Wilderness Country”, and a narrative interactive movie game in collaboration with the company's film and television business. We believe that on the basis that existing games such as “Chasing Deer in the Troubled World” and “Legendary World” continue to bring revenue to the company, the four reserved game projects in 2024 are expected to contribute to resilient performance.

Shanghai Ruyi invests in Wanda Film, and business collaboration can be expected in the future. On December 6, 2023, the company invested in Wanda Film through Shanghai Ruyi. 1) In terms of movies, achieve upstream and downstream business collaboration with Wanda Cinemas. The company adheres to the producer-centered development principle, and combines Wanda Film's “Elite +” cinematographer plan with theater user data and market trend feedback to form a high-quality content output cycle. In terms of IP ecosystem operation, Wanda Cinema Line provides offline channels, and combines Wanda Film's time network's rich derivative distribution experience to enable the company to develop IP resources. At present, the company has cooperated with Wanda Film on the 2024 summer animation “White Snake: Floating” to make every effort to build a derivative product line for this animated film to expand the company's brand influence and IP profitability through IP operation, R&D, production and sales of derivatives. 2) In terms of games, join hands with mutual love and interaction to expand the global market. We believe that Ruyi's Jingxiu Games and Wanda's subsidiary, which specializes in distribution in overseas markets, are expected to integrate resources in R&D, distribution, and operation.

Embrace AI to maintain its leading edge and establish the Pumpkin Film AI Technology Laboratory. In 2023, the company established the Pumpkin Film AI Technology Laboratory to achieve technological innovation in AI technology in various aspects such as script creation, character modeling, scene design, special effects generation, and music creation. We believe that as various technologies are reflected in multiple dimensions in AI films to be screened in 2024, AIGC technology will effectively reduce the production costs of current films. In terms of the game business, the company will launch one or more interactive narrative video games incorporating live action movies and TV within the year, and use AI technology to create some content, and collaboratively create games, film industry, and artificial intelligence through interactive video game products.

Investment advice: The film industry is recovering steadily in 2024. In this context, the competitive advantage and market share of leading high-quality film companies is expected to further increase. The orderly launch of superimposed game projects will contribute to performance flexibility, pumpkin movie streaming will increase the number of film and television channels, and AI film and television cost reduction and efficiency. We expect the company's revenue for 2024-2025 to be $52.7/7.37 billion (previous values were 41.16/4.732 billion yuan, respectively), with year-on-year growth rates of 45.2%/40.0%, respectively, net profit of 16.06/2,323 billion yuan (previous values of 1,24/ 1,493 billion yuan, respectively), and PE of 29.6/23.2 times for 24-25, respectively, to maintain the “buy” rating.

Risk warning: The recovery progress of the film market falls short of expectations, the box office of film projects falls short of expectations, the promotion of film and television projects is postponed, and cash flow risks due to fluctuations in operating performance.