1Q22 revenue in line, recurring net profit beat market expectation
ZTE announced 1Q22 results: Revenue rose 6.43% YoY to Rmb27.93bn, largely in line with market expectation. Attributable net profit grew 1.60% YoY to Rmb2.22bn and recurring net profit advanced 117.13% YoY to Rmb1.95bn, beating market expectation. The firm’s 1Q22 cash received from provision of goods and services grew 28.41% YoY, with cash paid for goods, labor service and employees increasing significantly YoY. As a result, ZTE’s net operating cash flow fell YoY, which we attribute to the firm’s inventory replenishment amid tight supply chain.
　　We believe recurring net profit beat expectation due to: 1) Gross margin (GM) of ZTE’s high-margin carrier business was further optimized thanks to R&D investment, and its revenue contribution also increased. This drove a 2.3ppt YoY and 6.8ppt QoQ expansion of blended GM to 37.8%. 2) FX loss declined YoY, driving an 86% YoY drop in financial expenses. Notably, YoY growth of attributable net profit in 1Q22 was negatively affected by high investment income in 1Q21 for disposal of its subsidiary Caltta and loss on fair-value remeasurement of derivative investments in 1Q22.
　　Trends to watch
　　Stable revenue growth for carrier network business; steadily improving its main growth engine. ZTE steadily enhanced its market share for 5G station procurement at telecom carriers. The Ministry of Industry and Information Technology seeks to increase the number of 5G base stations to over 2mn units by end-2022.[1] We expect ZTE’s revenue to benefit from accelerating 5G infrastructure construction in China by leveraging its competitive core technologies. The firm’s profit margin should also further improve along with rising self-supply of chips and optimization of production techniques, in our view.
　　Long-term growth potential for enterprise and consumer business; new growth engine taking shape. 1) Enterprise business: IDC data shows that ZTE’s global server shipment rose 87.9% YoY to 158,000 units in 2021. It has also secured high market share for servers and memory products in major telecom procurement recently. We are upbeat that ZTE will realize its target of 50% annual growth for the domestic enterprise business. 2) Consumer business: According to its official website, consumer business’ overseas revenue increased by about 30% YoY in 1Q22. The firm has kept rolling out new products, such as the Blade V40 smartphone and the upcoming new flagship handset Axon 40.
　　Financials and valuation
　　We maintain our 2022 and 2023 earnings forecasts. The H-shares are trading at 7.5x 2022 and 6.2x 2023 P/E. The A-shares are trading at 12.3x 2022 and 10.2x 2023 P/E. We maintain an OUTPERFORM rating for the H-shares and A-shares, and TPs for the H-shares at HK$20.73 (10.1x 2022 P/E and 8.3x 2023 P/E, offering 33.9% upside from the current price), and for the A-shares at Rmb35.35 (20.0x 2022 P/E and 16.5x 2023 P/E, offering 62.2% upside).
　　Risks
　　Disappointing 5G business development; disappointing development of consumer and enterprise businesses.