Huayi Brothers Alert:Not ready to deliver;maintain Hold

Topline/bottomline decreased by 10%/17% yoy due to weak content in 2016

    Huayi Brothers announced 2016 annual report today. The company reported anet profit of RMB808m (mainly comes from its investment gain on itssubsidiaries’ shares disposal), down by 17% yoy. Total revenue ofRMB3,503m decreased by 10% yoy from RMB3,873m in 2015. The mainreason for the topline/bottomline miss is the underperformance of mediaentertainment business due to its disappointing box office in 2016. Thecompany also disclosed RMB63-68m net loss in 1Q17 (vs. net profit ofRMB262.5m in 1Q16). We maintain Hold with a new target price of RMB15from previous TP of RMB17.5.

    Maintain Hold because of future earnings uncertainty

    To recall, as there were more lower-quality Chinese movies in 2016, Chinesemovies generated RMB26.7bn box office revenue, down by 1.7% yoy. Notethat Huayi is not the only company reported disappointing results due to weakcontent in 2016. We maintain Hold on Huayi Brothers because we remaincautious on the name given the high uncertainty of movie production returnand its volatile earnings. As per disclosure of the annual report, Huayi Brothersconfirms its film pipeline of 8 movies in 2017, including Mr. Feng Xiaogang’s“Fang Hua”. The company also confirms pipeline of 17 drama series(including TV and online) and 11 entertainment shows.

    We cut our 2017 earnings forecast

    As we expecting a rebound of the movie sector in 2017, we basically maintainour strong 2017/18 revenue growth forecasts of c.50%/35% yoy for MediaEntertainment. As a result, we lower our TP to RMB15 because we cut ourearnings forecast in 2017/18 by 14.6%/11.6% to RMB1,062m and RMB1,329mwith a yoy growth of 31%/25% in 2017/18. This is mainly due to the lowerbase in 2016 (owing to weaker content of media entertainment business).

    Valuation and risks

    We derive our target price of RMB15 from a DCF-based valuation (8.6%WACC, equity risk premium of 5.6%, risk-free rate of 3.9%, beta of 1.1 and 4%terminal growth rate for the strong long-term growth potential in China'smedia entertainment sector.). The stock trades at 25.3x 2017E PER but at amuch lower multiple (20.4x) on our 2018E earnings. This seems fair to usamong its peers under our coverage of 28x 2017E PER. Thus we maintainHold rating. Down risks include lower-than-expected return from films, andproduction delay. Upside risks include better-than-expected box officeperformance.