Revenue for the first quarter of 2024 was slightly higher than our expectations. Non-IFRS operating profit was better than our expectations for Tencent's 1Q24 revenue growth of 6% to 159.5 billion yuan, which is slightly higher than our expectations; non-IFRS operating profit also increased 30% to 58.6 billion yuan, higher than our and market expectations of 9.4%/10.8% respectively, mainly due to higher gross margins of the VAS and FBS business than expected and proper cost management.

Development trends

Tencent's advertising revenue potential is further exploited. The company's 1Q24 advertising business revenue also increased 26% to 26.5 billion yuan. Video accounts, applets, public accounts, and search ads all showed significant growth. In addition, AI advertising technology platforms also helped. The company said the total length of 1Q24 video accounts increased by more than 80% year-on-year, and the total length of applets also increased by more than 20%. We believe that Tencent advertising may show more commercial potential based on user behavior and traffic trends (such as video accounts and applets). Although the growth rate of video channel traffic will inevitably slow down due to technical factors, advertising growth may not only rely on video accounts as a driver. We expect 2Q24 advertising revenue to increase 14% year over year to 28.5 billion yuan.

Game traffic has resumed growth, and FBS's business is performing steadily. The company's 1Q24 game revenue was 48.1 billion yuan, which was basically the same year on year. Among them, overseas game revenue increased 3% year on year, and domestic game revenue decreased 2% year on year. The company said: 1) Overseas, Supercell 1Q24 sales increased 34% year over year; 2) On the domestic side, old games such as “King” and “Peace Elite” have been adjusted, and March sales have achieved positive year-on-year growth; sales of other popular games such as “Golden Shovel” and “CrossFire Mobile Game” reached a record high in 1Q24.

Combined with the above factors, we expect Tencent's game revenue to increase by xx% in 2Q24. In addition, adding the “DNF” mobile game to the 2Q24 factor, we think we can focus on observing the elasticity of Tencent's game business in the future. Furthermore, the company's 1Q24 financial and corporate services revenue also increased 7% to 52.3 billion yuan — of which the financial business growth rate slowed year-on-year, but we believe that the financial derivatives business is currently small and still has room to gain momentum. Enterprise service revenue achieved double-digit year-on-year growth in 1Q24. Video e-commerce led to an increase in technical service fees, and the cloud business continued to improve quality and efficiency to achieve high-quality growth. We expect revenue from financial and corporate services to increase by 10% in 2Q24.

The improvement in gross margin continued to exceed expectations. The gross margin of the 1Q24 company continued to increase by 2.6 ppt month-on-month, and the gross margin of all business lines in 1Q24 was higher than our expectations. We believe that Tencent's logic of leveraging gross profit leverage with its platform advantage remains the same -- it continues to provide support for high-margin businesses such as video ads, search ads, mini games, financial services, and video e-commerce. In addition, the company actively controlled expenditure. The 1Q24 non-IFRS operating margin reached 36.8%, and the non-IFRS net profit margin reached 31.5%. Based on high-quality growth logic, we believe that the company's 2Q24 non-IFRS net profit may have increased 38% over the same period. Furthermore, the company is continuing to carry out the HK$100 billion repurchase plan for the full year as previously announced. In 1Q24, Tencent's issued common shares decreased by 1.1% month-on-month, continuing to release shareholder value.

Profit forecasting and valuation

We basically kept our 2024 revenue forecast unchanged. Due to uncertainty in FBS and other businesses, we lowered our 2025 revenue by 2% to 703.7 billion yuan, but due to strong business leverage to reduce costs and increase efficiency, we raised 2024/2025 non-IFRS net profit by 12% and 10% to 2024/2025 to 2018/229.8 billion yuan. Maintaining the “outperforming industry” rating, the target price was raised by 12% to HK$468 based on profit forecasts, corresponding to 18.2x/16.0x2024e/2025e non-IFRS P/E, with 22.6% upside compared to the current stock price. The current share price is trading at 16.3x/14.3x 2024e/2025e Non-IFRS P/E.

risks

Regulatory risks; new game launches fall short of expectations; higher costs or fee rates than anticipated.