1H24 results are basically in line with our expectations

Ziguang Co., Ltd. announced its 2024 mid-year report: 1H24 achieved revenue of 37.951 billion yuan, up 5.29% year on year; realized net profit of 1 billion yuan, down 2.13% year on year; net profit after deducting non-return to mother was 0.894 billion yuan, up 5.78% year on year, which is basically in line with our previous expectations. Corresponding to the 2Q24 single quarter, the company achieved revenue of 20.945 billion yuan, an increase of 7.32% year on year; realized net profit of 0.587 billion yuan, up 0.60% year on year; net profit after deducting non-return to mother of 0.551 billion yuan, an increase of 8.46% year on year.

Development trends

As a leading manufacturer of ICT equipment, the company actively embraces the AI wave. By sector, 1H24's ICT infrastructure and service business revenue increased 5.43% year on year to 26.154 billion yuan, accounting for 68.92% of revenue; IT product distribution and supply chain services increased 6.26% year on year to 13.616 billion yuan. The subsidiary Xinhua 31H24's revenue increased 5.75% year on year to 26.428 billion yuan. Among them, domestic government business achieved revenue of 20.212 billion yuan (YoY +8.31%), and international business revenue increased 9.51% year on year to 1.198 billion yuan (H3C brand products and services autonomous channel business revenue increased 61.22% year on year to 0.416 billion yuan), and operator business revenue of 5.019 billion yuan (YoY -4.14) %). We believe that as a leading manufacturer of ICT equipment, the company is expected to benefit from continued growth in computing power demand.

Gross margin pressure is dragging down profitability, and operational efficiency continues to improve. The gross margin of 1H24 was 1.29pct to 19.0% year over year, of which the gross margin of the ICT infrastructure and service business was -1.06 pct to 24.37% year over year. We determined that it was mainly due to the impact of the restructuring of product and downstream demand. In addition, it was mainly affected by the reduction in government subsidies, and other income decreased by 0.452 billion yuan compared to the same period last year; mainly affected by the reduction in tax refunds from the subsidiary's Xinhua 3 accounts, income tax expenses increased by 0.153 billion yuan over the same period last year, which dragged down the company's net profit. We have seen that the company continues to optimize its organizational structure and improve operational efficiency. The 1H24 sales/management/R&D expenses ratio was -1.09pct/-0.11pct/ -1.34pct to 5.5%/1.2%/6.4% year-on-year.

We believe that as the effect of scale gradually becomes more prominent, the cost ratio is expected to improve and increase the company's profitability.

The acquisition of 30% of Xinhua's shares is progressing steadily. The company simultaneously announced the progress of the three equity acquisitions in Xinhua. The company has obtained documents and/or approval from Chinese government agencies under the “Revised and Restated Purchase Agreement for Shares to Sell Options” as a prerequisite for the settlement of this transaction, and has jointly signed merger and acquisition syndicated loan contracts of no more than 9.5 billion yuan with a number of domestic banks. We believe that if the acquisition is successfully completed, it is expected to increase the company's profits and enhance competitiveness.

Profit forecasting and valuation

As declining gross margin dragged down profitability, we lowered our 24/25 net profit by 15%/16% to 2.275 billion yuan/2.655 billion yuan. The current stock price corresponds to 2024/2025 23.8/20.4 times the price-earnings ratio.

Maintaining an outperforming industry rating, based on 30.0 times P/E in 2024, we lowered our target price by 16% to 23.87 yuan, which corresponds to 25.7 times the price-earnings ratio of 2025, with 26% upside compared to the current stock price.

risks

There is uncertainty about equity acquisitions, supply chain restrictions risk, and demand for digital transformation falls short of expectations.