4Q21: Net Profit In Line With Guidance
ZTE’s 4Q21 net profit declined 38% yoy to Rmb960m, at the mid-point of the profit alert. The qoq decline is due to delayed revenue recognition and a change in product mix as contribution from the lower margin business surged. Margins for all three major segments declined in 2H21 due to high base and rising component costs. For 2022, management remains confident in its carrier network and enterprise business,
maintaining their Rmb130b revenue guidance. Maintain BUY. Target price: HK$26.20.
RESULTS
• Full-year revenue grew 12.9% to Rmb114.5b, slightly below our expectations of Rmb115.1b. This was not entirely unexpected, as we were expecting the carrier network (+2.3% yoy to Rmb75.7b) to register lower-than-expected growth given the delayed tenders in 2021. Government and corporate business (+16.0% yoy to Rmb13.1b) was slightly above our expectations, while the robust consumer business (+59.2% yoy to Rmb25.7b) largely managed to offset the underperforming carrier network business.
• 2021 blended gross margin worse at expected at 35.2% (+3.6ppt yoy), while 4Q21 gross margins plunged 7.1ppt qoq to 30.9%. This was mainly due to higher contribution from the lower margin consumer business. ZTE’s core business, the carrier network segment, actually delivered stronger-than-expected margins of 42.5% in 2021. That said, all three segments’ margins contracted in 2H21, with enterprise/consumer business’ margins declining 1.8ppt and 5.0ppt hoh respectively, due to a normalising ASP for the consumer business and surge in component costs.
• 2021 operating expenses grew 20.4% yoy to Rmb33.8b, primarily due to surge in R&D expenses (due to increased R&D in carrier network/corporate business) and selling expenses (due to increased freight costs). However, the increased operating scale and gross margin expansion has more than offset the cost hikes. As a result, operating profit grew 64.2% yoy to Rmb6.6b, with operating margin expanding by 1.8ppt yoy.
• 4Q21 net profit came in at Rmb960m, declining 38.0% yoy and 45.9% qoq. The underperformance is mainly attributable to less favourable product mix and an inventory impairment loss of Rmb818m (vs Rmb112m in 2020). Full-year net profit grew 59.9% yoy to Rmb6.8b, roughly at the mid-point of its profit alert.
STOCK IMPACT
• Management maintained an unchanged 2022 revenue guidance of Rmb130b, indicating strong confidence in its carrier network and corporate business in 2022.
• Carrier network business: Delayed order booking to boost 2022 growth. As mentioned above, the revenue recognition was shifted to 2022 due to the late telco tenders in 2021. As a result, this will boost the segment’s growth in 2022. On top of that, we believe ZTE has been gaining market share in various wireline products such as switches, routers, optical transport network and servers, as Huawei continues to face supply constraints. As such, we now expect the segment to register high-teens growth in 2022 with stable margins at 42.5%.
• Enterprise business: Accelerating growth from domestic market. The segment’s overseas business was affected by the pandemic and registered a yoy decline in 2021, although this is more than offset by the >40% yoy growth in the domestic business. Going forward, we expect the domestic business to continue delivering robust growth on the back of China’s initiative to digitalise its economy, while the overseas business will remain stagnant as the company has shifted its focus and resources away from the overseas
enterprise business. Overall margins should remain largely stable at 27-28% in 2022-24, compared to 27.1% in 2021 and 26.3% in 2H21.
• Consumer electronics business to moderate from a high base. The segment’s robust growth in 2021 was mainly thanks to: a) market share gains from Huawei in consumer routers, and b) pandemic-driven demand from overseas. Given that countries have been opening their economies in 2022, we are expecting a yoy decline in 2022 from a high base. Gross margin should also normalise to pre-pandemic levels, at 17/18/18% for 2022-24 respectively.
EARNINGS REVISION/RISK
• We cut our net profit estimates for 2022-23 by 4.9/3.9% respectively to Rmb7,730m and Rmb8,821, mainly to factor in elevated R&D expenses, as well as a lower margin assumption for the enterprise and consumer business. This is partially offset by the stronger-than-expected margins for the carrier network business. We introduce our 2024 net profit estimate at Rmb9,714m, implying a 10.1% yoy growth.
VALUATION/RECOMMENDATION
• Maintain BUY but cut target price to HK$26.20, based on lower PE multiple of 13.1x, now pegged to 1SD below mean. While we believe ZTE will remain a key beneficiary of the digitalisation era, we are seeing mounting geopolitical risks amid the worsening US-China relations. The recent US court case regarding ZTE’s ex-employee will also be a major risk and overhang in the near future.