Core views:

The company disclosed 24Q2 performance: 24Q2 revenue of 25.49 billion yuan, YOY/QoQ +6%/-5%, Q2 gross margin increased by 3.08pct to 62.9%; sales expenses of 3.502 billion yuan, a year-on-month decrease of 12.94%, a year-on-year increase of 7.03%, sales expenses of 13.74%; management expenses of 1.091 billion yuan, management expenses of 4.28%; R&D expenses of 4.456 billion yuan, R&D expenses of 17.48%. 24Q2 GAAP net profit to mother was 6.759 billion yuan, non-GAAP net profit was 7.819 billion yuan, and non-GAAP net profit margin was 30.68%.

The gross margin of games increased steadily, and the growth of mobile games was under pressure. Revenue from 24Q2 games and related value-added services was 20.056 billion yuan, up 6.7%, of which online game revenue was 19.274 billion yuan, up 11.81%; mobile game revenue accounted for 76.4%, or 14.725 billion yuan, up 16.06%; PC game revenue accounted for 23.6%, to 4.549 billion yuan, down 0.05%, mainly due to the short-term impact of the “Dream Journey to the West” mobile game operation adjustments, which gradually stabilized in the third quarter. The company's classic mobile games are still at the top. Newcomer mobile games also performed well, and the 5th person ranking improved significantly.

Profit forecast and investment advice: In terms of the game business, the company's new games “Out of the World”, “Everlasting Mobile Game”, and “Marvel's Ultimate Reversal” have contributed to the increase in performance since this year. The “Dream Journey to the West” mobile game economy system was partially adjusted in the second quarter, and stabilized since the third quarter. The return of Blizzard's national service one after another will also complement the mobile game. In terms of game reserves, the company has reserved the card game “Marvel Clash”, as well as the multi-terminal game “16 Sounds of Yan Yun”, which combines Chinese martial arts with an open world system, which is expected to be launched within the year. In the long run, I am optimistic about the company's game development strength and ability to continue to produce high-quality game products. Youdao's main strategy in the future will focus on AI+ education two-wheel drive, and the gross margin of the cloud music business has improved markedly. We expect the company's overall operating income from 2024 to 2026 to be 109/122.5/133.6 billion yuan, and NON-GAAP net profit to be 33.3/37.2/40.7 billion yuan. Based on SOTP, the reasonable value per share is US$132.34/ADS (US stock) and HK$206.01 per share (Hong Kong shares), maintaining a “buy” rating.

Risk warning: User growth has entered a bottleneck, product cycle delays, and music copyright costs have increased.