Hikvision:Good start to the year

1Q17 operating profit grew 33%YoY but non-op missed forecasts.

    Hikvision started 2017 with strong growth in the first quarter. 1Q17 operating profit was 4% ahead of consensus, at CNY1.5bn, +33% YoY, driven by revenue growth (+35.5% YoY). GPM expanded to 43% with the competition easing and management focusing its effort on margins. However, pre-tax profits were 10%/9% below DB/consensus forecasts with lower-than-expected non-op income. Combined with a higher tax rate of 18%, 1Q17 net income registered CNY1.5bn, +29.5%YoY, for EPS of CNY0.25.

    2016 - growth with margin expansion but inventory days lengthened.

    Hikvision also announced its detailed 2016 annual results. The company continued gaining share, with 26% revenue growth, driven by 44% shipment growth. More importantly, we have been highlighting margin stabilization, and Hikvision’s GPM did recover 2ppt in 2016 from 2015 after years of decline. On the other hand, we are slightly concerned about the lengthening cash conversion cycle, from 88 days at the end of 2015 to 99 days at the end of 2016, mainly due to rising inventory days. The company has also proposed to pay a CNY cash dividend and a stock dividend of 50%.

    Growth momentum to sustain into 2017.

    Management expects 2017 profits to rise 15-35%, mostly driven by revenue growth. We expect revenues to grow 25%, with the public safety and transportation segments being the prime drivers. Despite management’s view on global macro uncertainty, the company still expects growth of overseas business to outpace Chinese domestic business. Hikvision still targets maintaining its GPM at over 40%, given its focus on its industry-leading position and profitability. The company expects opex ratio to remain at the current level (~20%), given its continual expansion of the R&D team in the innovation business and software such as data analytics. We expect OPM to be maintained at 21%.

    Valuation and risks.

    Hikvision is one of our top picks in the Asian hardware space. We are positive on the company’s continual market share gain and margin stabilization. The miss in 1Q17 results was mainly due to non-op, while its 33% YoY growth in operating profits marks a good start to 2017. While we slightly lower our earnings to reflect rising R&D efforts and lower non-op, we raise our target price from CNY40.8 to CNY41, as we roll over our valuation from 25x 2017E P/E to 25x 2H17-1H18E P/E. Risks: market share loss and weak demand.