1H22 results in line with market expectations
China Communications Services (CCS) announced its 1H22 results: Revenue increased 8.0% YoY to Rmb69.25bn and attributable net profit grew 4.6% YoY to Rmb1.90bn, in line with market expectations.
Trends to watch
Revenue from operator market grew steadily thanks to clients’ need for digital transformation. In 1H22, CCS’s revenue from the domestic telecom operator market rose 9.2% YoY to Rmb36.53bn, including Rmb22.73bn from China Telecom (up 18.8% YoY). Specifically, revenue from applications, content and other services from operators (ACO[1]) increased 38.8% YoY, largely due to accelerated digital transformation of the operator market and the firm’s efforts to develop cloud-based and network security business. Although operators decreased 5G-related capex, we still believe changes in their capex structure will bring construction and service demand for internet data centers (IDC), gigabit optical network, and cloud computing. We are upbeat that CCS’s revenue from the operator market will grow steadily in the future.
Business focus on major segments drove up revenue from non-telecom operator market; revenue from overseas market rallied. In 1H22, CCS’s revenue from the non-telecom operator market increased 6.5% YoY to Rmb31.17bn. Thanks to the rise of new segments such as digital government and smart city, revenue from the ACO business in the non-telecom operator market grew 26.1% YoY. The firm is actively exploring clients in construction and power sectors. In 1H22, the value of its newly signed contract with non-telecom operators grew 6% YoY, reaching Rmb40.9bn. We believe revenue from the non-telecom operator market will likely maintain double-digit growth in 2022, driven by major sectors’ need for digital transformation. In 1H22, revenue from the overseas market rallied, rising 12.7% YoY to Rmb1.55bn, boosted by large projects in Middle East and Southeast Asia. Specifically, revenue from the BPO and TIS businesses in overseas markets rose 111.2% and 11.8% YoY.
Ramping up R&D investment to enhance business strength; expenses declined thanks to cost control. In 1H22, CCS’s R&D investment increased over 18% YoY to Rmb1.92bn, mainly for developing application products. The firm has been tightening expense control: Selling, G&A and general expenses as a percentage of revenue dropped YoY to 8.5% in 1H22. We believe the decline in profit margin will contract in the future as CCS actively expands its digital business.
Financials and valuation
We leave our 2022 and 2023 earnings forecasts unchanged. The stock is trading at 5.8x 2022e and 5.5x 2023e P/E. We maintain an OUTPERFORM rating. However, considering that major telecom operator clients decreased their capex, we lower our TP by 12.6% to HK$4.37, implying 7.8x 2022e and 7.4x 2023e P/E, with 34.9% upside.
Risks
Disappointing capex of telecom operators; uncertainties in the implementation of the east-to-west computing resources transfer project.
[1]The firm’s businesses mainly include telecom infrastructure services (TIS), business process outsourcing (BPO), and applications, content and other services from operators (ACO). Its clients can be classified into telecom operator clients, non-telecom operator clients, and overseas clients.