19.9% YoY 1H23 earnings growth beats BOCI estimates and ahead of market consensus, despite softer topline from slower terminal sales and government/enterprise market. Steady improvement in carrier network equipment GM demonstrated the power of proprietary IC and key for the Company’s LT profitability. Reiterate BUY, TP revised down to HK$29.43 due to exchange fluctuation.
　　Key Factors for Rating
　　19.9% YoY 1H23 earnings growth to RMB5.5bn, beating BOCI estimates and also ahead of market consensus, despite softer topline only increased by 1.5% YoY to RMB60.7bn, 11% below our estimates.
　　Gross margin from carrier network equipment sales increased by 8.9ppts to 54.2% in 1H23, the highest in recent history and gross profit for the group also increased by 18% YoY to RMB26.2bn. Improved product mix with higher revenue growth from high margin products (core network products and data/fiber communication product) and adoption of proprietary semiconductors in the system help improve overall networking equipment gross margin.
　　Fully hedged on forex fluctuation: ZTE has conducted derivative trading in foreign exchange derivatives for value-protection hedging purposes with its internal funds during the first half of 2023 with net gain of RMB1.1bn.
　　Earnings revisions: we revised up our 2023-24E earnings by 11.8%, 12.4% and 11.6% respectively as we factor in higher gross margin from the Company’s carrier networking equipment sales. Higher level adoption of proprietary semiconductors in the Company’s networking equipment as Company strategy/policy unlikely to change under current environment, and likely carry on in the future product development in our opinion. On the other hand, we revised down our 2023-25E estimates sales by 3.6%, 5.1% and 5.8% as we revise down sales from consumer business and sales to government and enterprise businesses which is affected by current macro condition.
　　Key Risks for Rating
　　Supply chain disruption and shortage of key components and semiconductor products are the primary uncertainties on the company’s earnings.
　　Valuation
　　Reiterate BUY, and we roll over into mid-point of 2023/2024 earnings as our bench mark, with target PE unchanged at 12.8x 1 year forward or +1 Standard Deviation based on the company’s two year trading range . With updated CNY to HKD exchange rate at 1.079, we lowered our target price from HK$30.69 to HK$29.43.