Zhejiang Dahua Technology Co:Slower-than-expected sales growth,stabilizing margins;Neutral

What's changed

We recently spoke to Dahua management and key industrial player,Hikvision. Highlights include: Progress in Dahua’s new solution projects isslower than expected due to execution delay and may be recognized asrevenue in 2017;(2) gross margin stabilized in 2016due to more rationalindustry-wide price competition in distribution channels as small playerswere under great profitability pressure and were losing market share tolarge players like Hikvision and Dahua; (3) the industry is positive ongovernment spending in security surveillance system in 2017, and expectsstronger momentum in spending and more in PPP (Public-Private-Partnerships) projects compared to 2016; Dahua appears more aggressivein taking up PPP projects than Hikvision; (4) industry leaders are returningto margin-focus and both Hikvision and Dahua expect improving marginsin 2017as product mix tends to be more high-end biased.

Implications

We expect slower sales growth from slower ramp-up of new projects andthe impact of PPP projects on near-term topline are not likely be significantdue to delayed revenue recognition nature of such projects. As such, webelieve Dahua may need to be more selective on participating in PPPprojects.

Valuation

We cut earnings estimates by 3.3%-7.9% in 2016E-20E to factor in slowersales growth and more stable margins. Our 12m P/E-based TP decreasesby 2.1% to Rmb13.8, reflecting 2017E global peer average PE of 17X (was16X) on our 2017E EPS of Rmb0.81(was Rmb0.88). Maintain Neutral.

Key risks

Faster/slower sales growth; higher/lower-than-expected GM.