Concern on the higher R&D capitalization

用友网络(600588)
    Yonyou reported FY4Q22 revenue of RMB3.67bn (-8% YoY) and net profit of RMB759mn (+31% YoY), missed our/ consensus estimates by 13/ 17% respectively. The weakness was due to COVID-19 resurgence and GPM erosion given higher staff cost and outsourcing expenses. For cloud segment,revenue showed no YoY growth although ARR was up +23.8% YoY. ARR contribution to cloud revenue was stable at 32% (vs. 58% for Kingdee), which suggested majority of Yonyou’s cloud revenue is not recurring. We are also concerned with the increasing R&D capitalization rate to record-high of 48%.Deteriorating earnings quality could result in share price de-rating.Downgrade from HOLD to SELL.
    FY4Q22 missed with no growth in cloud revenue. Yonyou reported weak FY4Q22 results with revenue of RMB3.67bn (-8% YoY) and net profit of RMB759mn (+31% YoY), both missing our and consensus estimates. Cloud service revenue showed no growth at RMB2.81bn,accounting for 77% of revenue while Software business continued to shrink (-29% YoY). Operating profit was RMB750mn (-19% YoY), and lower opex ratio at 39.1% (-3.6 pcts) was offset by the decline in GPM (-6.3 pcts YoY to 59.5%). Yonyou attributed the GPM erosion to higher staff cost (no. of employee +21% YoY in 4Q22) and outsourcing expenses.
    Customer mix has limited the ARR and cloud revenue visibility.Although ARR growth remained steady (+23.8% YoY to RMB2.04bn),ARR accounted for only 32% of cloud revenue, similar to the 31% in FY21. This implied majority of Yonyou’s cloud revenue is not charged on subscription basis and is not recurring in nature. This could be explained with Yonyou’s customer mix that skewed towards large-sized enterprises (69% of FY22 cloud service revenue). The customization demand from large-sized enterprises will limit the ARR and its cloud revenue visibility.
    R&D capitalization rate hit record-high of 48%. In FY22, Yonyou increased R&D expenditure by +24% YoY to RMB2.93bn as the Company continues to develop cloud-native products. R&D capitalization rate rose to record-high of 48% (vs. 36% in FY21, vs. Kingdee’s 33% in FY22). Assuming all R&D are being expensed, Yonyou suffered from net loss of RMB1.18bn in FY22, significantly widened from net loss of RMB137mn in FY21. We are concerned with the deteriorating earnings quality.
    Downgrade from HOLD to SELL. We cut FY23-24E net profit by 7-9% to reflect lower cloud revenue growth and GPM. Downgrade to SELL with new target price of RMB19.56 (prior RMB22.27), based on unchanged 6.0x FY23E EV/sales.