Upside risks: (i) accelerated execution of Dabaozhuan or premiumisation; and (ii) like-for-like price hikes. Downside risks: (i) intensified competition; (ii) commodity inflation; and (iii) consumer preference change.
　　Valuation
We revised up 2023E NP forecast by 4%, with lowered SG&As and tax rate more than offsetting GP margin cut. We revised down 2024/25E NP forecast by 3/2% mainly on GP margin cut. We derived our new TP of HK$6.8 (up 10% from previous HK$6.2), on 15x 2024E P/E (rolled forward from 17x 2023E P/E).
　　Key Factors for Rating
　　2Q net profit increased by 14.4% YoY to RMB7.24bn, beating BOCI estimate by 2.6% and also ahead of street consensus, with 6.1% YoY increase in service revenue, in line with our estimate.
　　EBITDA increased by 5.4% YoY in 2Q to RMB27.8bn while EBITDA margin trended down 0.4ppt YoY to 32.8% due to the increase in network operation and support expenses, which we believe is the result of rising R&D and product development required for cloud/Ai related businesses as the company develops full stake proprietary products. EBITDA erosion slowed YoY, indicating improving profitability from higher growth “emerging to B businesses”, while the margin gap compared to traditional “to C” telecom businesses is getting narrower.
　　Interim dividend up 23% YoY. The company proposed interim dividend of RMB0.203 per share for 1H23, representing a YoY increase of 23% compared with that of 1H22.
　　Faster growth of innovative business: Industry Internet revenue reached RMB43.0bn in 1H23, up by 16.3% YoY and accounting for 25.1% of service revenue for 1H23. Management reiterate their objective for full year 2023 with cloud revenue exceeding RMB50bn.
　　Key Risks for Rating
Supply chain disruption may hinder the company’s initiatives on cloud service and industrial internet businesses. US sanction on financial investment continues to overhang the company’s valuation.
　　Valuation
Reiterate BUY, and maintain DCF based target price at HK$ 7.47. Capex to sales ratio declined to 22.9%.
　　Heading
2Q/1H 2023 results review.