ZTE Corporation (763 HK):Best 4G capex proxy play

Still a buy. Higher telecom equipment spending from leading telecom operators and signs of improvement at the handset division underpin our positive outlook on ZTE. We maintain our Outperform rating on the stock but reduce our FY14F/15F earnings forecasts 4.7%/16.3% to reflect slower sales at the handset division. We also lower our target price on ZTE from HK$20.00 to HK$19.00, still basing it on 20x FY14 P/E, in line with the average 3-year mid-cycle P/E valuation for the previous 3G telecom capex cycle.

In line 1Q14. ZTE reported 1Q14 results under PRC GAAP. Sales revenue was up 5.5% YoY to RMB19.1b while net income rose 204% YoY to RMB622m, in keeping with the pre-announcement. GPM in 1Q14 was up 720bp to 33.5% versus 26.4% in 1Q13 owing to strong sales revenue from telecom operators. ZTE expects 1H14 net income to fall in the RMB800m-1.0b range, a 158-223% YoY increase.

Looking forward to the 4G capex cycle. China Mobile has been increasing 4G telecom capex and we see potential upside from China Telecom and China Unicom. In our view, ZTE will be a key beneficiary of the telecom capex boom we expect in 2014F/2015F. The GPM recovery in 1Q14 suggests robust sales revenue from telecom operators. We forecast 11% YoY sales revenue growth from the carrier networks division this year.

Handset division making the right moves. According to IDC, ZTE shipped 36m smartphones in 2013, a 17.5% YoY increase. In 2014F/2015F, we expect shipments of 55m/70m units as ZTE shifts its product mix towards mid- to high-end smartphones with better GPM just as 4G smartphone sales take off in the domestic market later this year. We expect 12% sales revenue growth at the handset division and 15% GPM for 2014F, a 35bp increase on last year.