Inspur International （Inspur） hosted its 1H 2019 results presentation yesterday. Thesharp YoY decline in contribution from an associate created a negative surprise for themarket. But the core software business reported faster growth than its peers’。
In our view, Inspur is one of the beneficiaries of increasing localization, which shouldsupport the Company’s operating performance.
The contribution from an associate is down YoY, but is expected to report sequentialgrowth in 2H 2019.
We believe that the negatives have been priced in.
We maintain our ADD rating, with a new target price of HK$4.59 （based on a 21x2019 PER）， down from HK$5.84, mainly because of a downward revision in our netprofit forecasts.
1H 2019 results highlights
Inspur reported a 16.4% YoY decline in net profit, from HK$135.5m in 1H 2018 （restated）to HK$113.2m in 1H 2019. The Company’s turnover rose 24% YoY from HK$1,115.3m（restated） to HK$1,391.2m in 1H 2019. Inspur’s turnover growth in 1H 2019, especially inits traditional software business （up 16% YoY） outperformed its peers, including Kingdeeand Yonyou, in 1H 2019. The YoY decline in net profit was mainly due to a 67.7% YoYdecline in contribution from an associate, from HK$65.9m in 1H 2018 to HK$21.3m.
Inspur management said software remains a growth driver （75% of total turnover in 1H2019 vs. 81% in 1H 2018） and a major profit contributor （137% of total segment profit in1H 2019 vs. 122% in 1H 2018）。 The profitability of the management software divisionimproved YoY, and its segment profit margin improved from 12.6% in 1H 2018 to 13.7%in 1H 2019. Turnover of cloud services grew 104.4% YoY to HK$160.6m in 1H 2019, butthis segment still reported a segment loss of HK$45.2m in 1H 2019 vs. HK$23.1m in 1H2018）。 The number of cloud services users grew 160% YoY. Inspur management ispositive on the outlook for the cloud industry, but said the Company will adopt aconservative strategy compared to its peers. The losses from cloud services areexpected to be contained, and the segment is unlikely to significantly drag down overalloperating performance. The YoY decline in contribution at the associate level wassomewhat expected （we originally factored in a 15% YoY decline in contribution from anassociate, but the actual performance was much weaker than expected）。 Turnover in IoTsolutions grew 37.2% YoY to HK$187.1m in 1H 2019.
Investment themes remain on track
We believe that two investment themes will remain the drivers of the China TMThardware sub-segment: a） the change from CAPEX investment to OPEX investment, andb） increasing localization. Given its track record and background, we expect Inspur to beone of the beneficiaries of increasing localization. According to Inspur management, theCompany has received more enquiries from SOEs regarding cloud transformation and ITinvestment. Management believes that the Company’s growth in 2019 and 2020 will besupported by a more favorable environment, driven by government policy.
Downward net profit revision
The YoY decline in contribution at the associate （Qingdao Lejin Inspur DigitalCommunication） level was somewhat expected （we originally factored in a 15% YoYdecline in contribution from an associate, but the performance in 1H 2019 was muchweaker than expected）。 The contribution from the associate was down YoY, but weexpect it to report sequential growth in 2H 2019. We revised down our net profit forecastsfor 2019 and 2020 by 23.0% and 21.3%, respectively, mainly due to a cut in our forecastfor the contribution from the associate.