Hikvision:In the fast lane,initiating with Buy

Initiating coverage with Buy and target price of CNY40.8.

    We initiate coverage on Hikvision (002415 CH), the global leader in the videosurveillance industry, with a Buy rating and a target price of CNY40.8, basedon 25x 2017E PE. We expect widening IoT applications and Hikvision’sexpanding product portfolio to sustain its long-term growth. As a result of newproducts, its market share is rising towards 28% and margins are stabilizingwith scale and a rising proportion of solution business revenues. The sharesare on 15x currently and should re-rate to better reflect 27% earnings growth.

    Riding on the IoT/Smart city boom.

    We expect the video surveillance industry to benefit from the surging growthof IoT as network cameras capture images/data. These cameras are alsoessential in various smart city implementations in keeping citizens safe andimproving their quality of life. Market research firm, Frost & Sullivan, estimatessmart city spending will reach US$1.5tr in 2020. We believe more than half ofHikvision’s total solutions business is related to the IoT/smart city and weexpect the solution business to benefit from the IoT/Smart city boom.

    A market share gainer.

    Hikvision's global market share has expanded rapidly from 7.9% in 2012 to18.1% in 2015. We expect the share gain trend to continue and reach 27.5% in2018 on the back of its lower cost structure, one-stop-shop strategy withcomplete product line-ups, early entry into aerial surveillance and closeproximity to the fast-growing Chinese market, at a 17% CAGR in 2015-19E.

    Margin pressure to subside.

    Hikvision's margin has declined since 2010 due to its lower pricing strategy toexpand market share with rapid shipment growth. While we expect the pricepressure to persist as Hikvision gains further share, we also expect marginerosion to be partially offset by rising economies of scale with a lower opexratio and a rise in the more lucrative total solutions business. We expect OPMto stay at 21-22% over the next few years.

    Valuation and risks.

    We base our target price of CNY40.8 on 25x 2017E P/E, in line with itshistorical average of 24x. We believe the valuation is justified by strongearnings growth, net cash position and an average ROE of 38% during 2016-18.

    The key risks are a market share loss and weaker-than-expected demand.