SenseTime announced 1H24 results on 27 Aug: total revenue grew by 21% YoY to RMB1.74bn, largely in line with our estimate; adjusted net loss narrowed by 3% YoY to RMB2.33bn with net loss margin improving by 33ppt YoY to -134%, which is below full-year consensus margin estimate of -79% due to continuous investments in foundations models and generative AI application development. Looking ahead in 2H24E, we expect total revenue growth will further accelerate to +33% YoY, driven by the robust growth of Gen AI business. We maintain our FY24- 26E total revenue forecast largely unchanged but expect larger adjusted net loss of RMB3.5/2.5/1.7bn over FY24-26E (previous: RMB3.1/2.3/1.6bn), mainly due to more conservative GPM outlook as SenseTime will expand its computing power through a partner network. We fine-tuned our target price to HK$1.36 based on 6.5x FY25E EV/sales (previous: HK$1.25 based on 7.0x FY24E EV/sales), a premium to the average EV/sales of China's AI peers (5.2x), reflecting SenseTime's strong positioning in the Gen AI market.

Gen AI business as the key growth driver. Gen AI business revenue increased by 256% YoY to RMB1.05bn and represented 60% of total revenue in 1H24 (1H23: 21%), fuelled by the strong demand for large models and AIDC. The number of users registered for SenseNova MaaS grew by 725% from Jan to Jul 2024. As per IDC, SenseTime became the third largest AIDC service provider in China in 2H23, with market share of 15.4%. Smart Auto business revenue grew by 100% YoY to RMB168mn in 1H24. 705k new vehicles were delivered in 1H24, up 80% YoY. SenseTime was confirmed as the designated supplier for 15 new models in 1H24, which represents additional 6mn vehicles and will support future growth of Smart Auto. Traditional AI revenue declined by 51% YoY to RMB520mn in 1H24, primarily due to adjustment of Smart City business.

Positive on SenseTime's Gen AI competitive edge. For 2H24E, we expect SenseTime's total revenue to grow by 33% YoY to RMB2.62bn, mainly driven by 75% YoY growth in Gen AI business revenue. We are upbeat on SenseTime's positioning in China's Gen AI market, given its: 1) strong AI infrastructure with total operational computing power exceeding 20,000 PetaFLOPS, and management expects it to surpass 25,000 PetaFLOPS by end-FY24; 2) solid operational capabilities for large-scale AI clusters; 3) independence (had no direct competition) to its suppliers and clients.

More conservative GPM outlook in FY24-26E. GPM was 44.1% in 1H24, down 1.2ppt YoY, mainly due to the increase in AIDC operation costs. Thanks to the operating leverage and control in selling & administrative expenses, adjusted net margin improved by 33ppt YoY to -134% in 1H24. Looking ahead, we expect the GPM will gradually decline to 38% in FY26E, as SenseTime will expand its computing power through partner network instead of its own capex investments. However, this adjustment should improve its cash flow and financial flexibility. For its long-term path to profitability, we expect SenseTime will need to make meaningful improvement in operating efficiency.