2021 results slightly missed market expectations
　　China Communications Services (CCS) announced its 2021 results: Revenue rose 9.2% YoY to Rmb134bn, net profit increased 2.5% YoY to Rmb3.16bn, and adjusted net profit grew 5.4% YoY to Rmb3.25bn.Dividend increased 8.1% YoY in 2021, implying a dividend payout ratio of 38%. The 2021 results slightly missed market expectations as profit was under pressure due to price cuts by telecom operators and rising cost of raw materials.
　　Trends to watch
　　The operator business grew steadily. In 2021, revenue from the　domestic telecom operator business rose 5.5% YoY to Rmb73.8bn, accounting for 55.1% of total revenue. CCS adopts the CAPEX and OPEX + Smart Applications strategy, develops telecom infrastructure services (TIS) along with the 5G network construction, and has achieved rapid revenue growth (+21.5%) from applications, content and other services from operators (ACO), driven by the digital transformation of telecom operators. We believe revenue from the operator business will grow steadily along with the capex growth of telecom operators.
　　The non-telecom operator business maintained double-digit growth and served as the main revenue growth driver. In 2021, revenue from　the non-operator business rose 15.9% YoY to Rmb57.4bn, accounting for 42.9% of total revenue (2.5ppt higher than a year ago). CCS has further reducedd its dependence on telecom operators. The company is capitalizing on industrial-digitalization opportunities to develop new infrastructure and smart industry solutions, focusing on key industries such as government, IT, power, and transportation. New contract value increased more than 10% YoY to Rmb76.3bn in 2021. We believe this business may maintain double-digit growth thanks to the digital transformation.
　　Decline in gross margin moderated, while net margin remained under　pressure. Gross margin fell 0.2ppt YoY to 11.0% in 2021. Net margin slipped 0.1ppt YoY to 2.4% in 2021. Profitability continued to be under pressure due to price cuts by domestic telecom operators and rising prices of raw materials. We expect gross margin to gradually stabilize as the company continues to expand its higher-margin businesses such as smart applications, and strengthen management of the subcontracting process and the entire project process.
　　Financials and valuation
　　Given the prudent capex of telecom operators and the uncertainty in the implementation of the east-to-west computing resources transfer project, we cut our 2022 revenue forecast 2.5% to Rmb145.1bn and our 2022 earnings forecast 12.0% to Rmb3.34bn. We introduce 2023 revenue and earnings forecasts at Rmb156.3bn and Rmb3.55bn. Maintain OUTPERFORM rating. To reflect valuation contraction of the H-share communications sector, we lower our target price 23.1% to HK$5.00 (8.9x 2022e and 8.4x 2023e P/E), offering 28.5% upside. The stock is trading at 6.9x 2022e and 6.5x 2023e P/E.
　　Risks
　　Disappointing capex of telecom operators; uncertainties in the implementation of the east-to-west computing resources transfer project.