2Q24 results are in line with our expectations

Zhongji Xuchuang announced its 2024 mid-year report: 1H24 achieved revenue of 10.799 billion yuan, a year-on-year increase of 169.70%, and net profit to mother of 2.358 billion yuan, an increase of 284.26% year-on-year, after deducting non-net profit of 2.333 billion yuan, an increase of 300.07% year-on-year. Corresponding to the 2Q24 single quarter, the company's revenue was 5.956 billion yuan, up 174.88% year on year, up 22.99% month on month; net profit to mother was 1.349 billion yuan, up 270.82% year on year, up 33.68% month on month. The results were in line with previous forecasts and our expectations.

Development trends

North American Cloud Capex continues to increase AI, and demand for 400G+ optical modules remains high. 2Q24 North America's top 4 cloud vendors (Amazon, Google, Microsoft, Meta) had a total capital expenditure of 52.852 billion US dollars, up 57.8%/19.3% month-on-month. All major cloud vendors have indicated that they will continue to actively invest in AI. We believe that demand for optical modules, as an important part of the network side of AI investment, is expected to maintain strong growth. According to LightCounting's forecast, the global AI digital optical module market CAGR will reach 47% in 2023-28, with 400G+ optical modules as the main growth driver. We expect that with the gradual maturity of the 800G Ethernet hardware ecosystem and the accelerated penetration of Ethernet networking solutions in intelligent computing centers, global demand for 800G optical modules is expected to continue to increase in 2025; at the same time, 1.6T is expected to cooperate with key major customers to achieve volume shipments in 2025.

Leading suppliers are expected to fully benefit from long-term trends, with silicon light capabilities leading the guarantee share advantage. As a global leader in high-speed optical modules, we believe that Xuchuang can fully benefit from industry trends. 2Q24's revenue achieved a month-on-month growth rate of more than 20% for the fourth consecutive quarter. According to the announcement, it mainly focuses on 400G and 800G products, and the company's 1.6T products are successfully introduced into the market, so we judge that it is expected to enter mass production by the end of 2024. The company maintains leadership in the field of silicon optical technology. Some silicon chips have entered the mass production stage, and silicon optical modules are being introduced into the market at an accelerated pace. We believe that the company has always maintained a leading position in high speed and new technology iterations, and has a stable share in the high-end market.

Multi-dimensional factors have driven significant improvements in profitability. 2Q24's gross margin and net margin were 33.4% and 22.7%, respectively, up 0.6pp/1.9ppt from the previous month. According to the announcement, the company's profitability improvement is mainly due to factors such as improved yield, improved production efficiency, supply chain optimization, and refined product structure. Looking ahead to the future market, the company plans to strictly control period expenses. We judge that there is still room for optimization of the company's expenses during the period. Profitability is expected to stabilize at a high level against the backdrop of high demand.

Profit forecasting and valuation

Due to increased demand from major North American CSP customers and an upward trend in the company's profitability, we revised our 2024/25 profit forecast 7.7%/8.8% to 5.519/9.373 billion yuan. The current stock price corresponds to 24.4/14.3 times P/E in 2024/25. Maintain an outperforming industry rating, taking into account the increase in profit forecasts and the downward shift in the industry valuation center, and maintain the target price of 169.11 yuan, corresponding to 34.4/20.2 P/E and 41% upward space in 2024/25.

risks

AIGC's development fell short of expectations; upstream core materials were scarce; 1.6T competition intensified, etc.