The business is transforming from traditional media to digital media, and profit margins are still under pressure. In 2017, revenue from traditional media agency business fell 8.3% compared with the same period last year, while revenue from digital media business increased by 35% over the same period last year. This is in line with the industry trend of shifting advertising budgets from traditional media to digital media. In the future, we expect the company's digital media business to maintain rapid growth (an average annual compound growth rate of 33% in 2017-21) and will be the main driver of the group's revenue (14% in 2017-21).

As of 2017, Shengguang's digital marketing business accounted for only 39% of total revenue, and we expect that proportion to rise to 71% by 2021. The company's transformation lags behind blue cursor, which accounted for 87% of its total revenue in 2017. However, the dilution of profit margins is one of the costs of its transformation. As the revenue contribution of Blue cursor digital marketing increased from 46% in 2013 to 87% in 2017, its digital advertising gross profit margin also fell from 28% to 16%, and the overall gross profit margin fell from 35% to 18%.

Therefore, in view of the continuing challenge posed by the increasing bargaining power of downstream digital media (BAT, Jinri Toutiao, etc.), we expect the gross profit margin of Shengguang's digital marketing business to fall from 16% in 2017 to 12% in 2021. In the first quarter of 2018, gross profit margin continued to fall 2 percentage points year-on-year to 15%, indicating that the company still faces structural challenges, and we do not think this gross margin level has yet to hit bottom.

Goodwill impairment risk

In 2017, the company confirmed a goodwill impairment loss of 196 million yuan, mainly due to the operational difficulties faced by its three subsidiaries. The company also confirmed that the loss of bad debts on accounts receivable was 450 million yuan. As of 2017, the company's goodwill (after impairment) was 2.05 billion yuan, mostly from several digital advertising subsidiaries that had achieved their 2017 profit targets. However, as the profit targets of these subsidiaries expire in 2018, if operations deteriorate, we believe that these companies may bring further goodwill impairment risk.

Profit forecast and valuation

We cut our earnings per share forecast for 2017-21 by 32 per cent to reflect the decline in profit margin assumptions and correspondingly lowered the 12-month target price from Rmb5.38 to Rmb3.67, still based on a price-to-earnings ratio of 18 times expected earnings per share for 2021 and discounted back to 2018 at 8 per cent of the industry's cost of equity. The neutral rating of the stock is maintained due to limited upside space (9%).