20151209-中国银河国际证券-中兴通讯-00763.HK-Concerns_on_growth_outlook_overdone.Initiate_with_BUY_23页_1mb

ZTE Corporation Summary (December 09, 2015)

Core Content

ZTE Corporation (763.HK) is a leading Chinese networking hardware company, providing products and services across various sectors including switches, access servers, video conferencing systems, mobile communication devices, and optical communications. The report highlights the company's strong growth outlook and initiates a "BUY" recommendation with a target price of HK$21.95, based on a 21.0x 2015E PER, aligning with its historical average of 22x.

Main Points and Key Information

1. Growth Drivers

• Wired Equipment and Overseas Sales: ZTE's wired network investment and overseas expansion are key growth drivers. The company is expected to report a 23% YoY sales growth in networking products for 2016.
• New Business Development: ZTE is expanding into new business areas such as wireless charging for electric vehicles and IT services. These areas are expected to contribute to long-term growth.
• Government Policy: The Broadband China policy is creating significant growth opportunities for ZTE in the FTTx/broadband access market. The policy aims to increase broadband speed and coverage across China.

2. Smartphone Segment

• The smartphone segment is no longer a drag on ZTE's performance. Strong shipments in the US helped offset weakness in the Chinese market.
• ZTE's smartphone sales percentage from China dropped to below 40% in 2015 from 50% in 2014.
• ZTE's gross profit margin on smartphones is about 15%, which is higher than the negative margin in the Chinese market.

3. Financial Outlook

• ZTE is forecasted to deliver solid net profit growth of 38.5% in 2015E, 22.5% in 2016E, and 23.6% in 2017E.
• The company's gross margin is expected to improve from 27.2% in 2013 to 30.7% in 2017E, driven by better product mix and cost control.
• ZTE's net profit margin is also expected to rise, from 0.7% in 2013 to 5.0% in 2017E.
• Free cash flow per share is projected to increase from -0.1 in 2013 to 1.4 in 2017E.

4. Market Position and Strategic Initiatives

• ZTE is well-positioned to benefit from the growth of the Chinese broadband and cloud computing markets.
• The company has made progress in the government and enterprise network, smart city, and automobile battery charging sectors.
• ZTE has formed strategic alliances with major players in the EV and smart home markets, enhancing its position in emerging technologies.

5. IC Design and Local Supply Chain Development

• ZTE is a beneficiary of China's government policy to build a local IC supply chain. Its subsidiary, ZTE Microelectronics, has received significant investment from the National IC Fund.
• The company aims to increase its IC self-sufficiency rate, aligning with the "Made in China 2025" initiative.
• ZTE Microelectronics is one of the leading IC design houses in China, with a focus on advanced baseband chips and other high-margin products.

6. Risks

• Increasing competition in the market.
• Lower than expected sales of network equipment.
• Substantial forex losses.

Key Financials (in RMBm)

Key Assumptions and Growth Projections

• Wireless System: Expected to grow from 21,930.8 RMBm in 2011 to 39,067.2 RMBm in 2017E.
• Wired System: Expected to increase from 7,132.1 RMBm in 2011 to 9,157.8 RMBm in 2017E.
• Other Products and Services: Projected to grow from 17,459.1 RMBm in 2011 to 14,899.0 RMBm in 2017E.
• Handset Sales: Expected to decline slightly in 2015E, with a forecasted revenue of 21,800.0 RMBm.
• Software and Data: Expected to grow significantly, reaching 28,505.8 RMBm in 2017E.

Conclusion

ZTE is positioned for long-term growth due to its diversification into new markets and technologies, as well as the supportive government policies in China. Despite challenges in the smartphone segment, the company is expected to benefit from increased demand in the broadband and cloud computing sectors, as well as from its strategic investments in IC design and wireless charging technology. The report suggests that the current valuation of 16.5x 2015E is attractive and offers a re-visit point for potential investors.