Hangzhou Hikvision:Margin stabilising,focusing on innovative business,maintain Buy

What's changed

We recently talked to company management and key industry players; ourkey takeaways are as follows.(1) Hikvision has made important progressin its innovative business, like robotic warehouse system contracts withthe Linyi warehouse of Shentong Express (002468.SZ; Not Covered) andHigh Store Tech (unlisted; NetEase’s Kaola is one of its key clients).(2)According to management, Hikvision’s distribution sales have slowed andit currently has a significant market share in distribution.(3) Industrywidepricing competition in distribution channels has eased in 2H16, as smallplayers had faced significant profitability pressure and were losing marketshare to large players like Hikvision and Dahua. (4) The industry viewsgovernment spending on a security surveillance system in 2017positively,and expects stronger momentum in spending and more PPP (Public-Private-Partnership) projects vs. 2016.(5) Industry leaders are returningtheir focus to margins, which both Hikvision and Dahua expect to improvein 2017, as product mixes tend to be high-end biased.

Implications

We expect lower sales growth in the distribution market in 2017due to thecompany easing up on its aggressive market penetration strategy.However, we believe Hikvision’s stabilized margins and new contributionsfrom its innovative business will partially offset the negative impact. Wesee the company’s advantage in image processing as a natural fit forbusinesses including robotics, auto electronics and home surveillance.

Valuation

We cut our 2016-19earnings estimates by 6%/4%/4%/1%, but raise our2020estimate by 5% to reflect slower sales growth, higher margins andHikvision’s innovative business. We lower our 12-month 2017E P/E-basedtarget price by 3.6% to Rmb26.9(unchanged 17X 2017E global peers’median on 2017E EPS of Rmb1.58[was Rmb1.64]). Maintain Buy.