ZTE CORPORATION:Down but not out

Looking for in-line 1H16F results. We expect revenue will have increased 7.8% YoY to RMB49.5b in 1H16F, with the result having been blunted by US export restrictions in 1Q16. We look for 1H16F net profit growth of 17.0% YoY, gross margin to have held steady at 30.3% and the opex-to-sales ratio to have declined 162bp on improved economies of scale.

Modest growth for telecom equipment and consumer products in 2016F. In our view, when it comes to investing, ZTE can be considered a proxy for China’s telecom industry. We expect carrier network sales at ZTE to record 9% YoY growth in 2016F given (1) modest growth in overall China telecom equipment orders during the late 4G cycle, (2) surging domestic data demand, and (2) incremental pre-5G orders from overseas. On the consumer business front, we forecast flat smartphone unit sales in 2016F accompanied by robust 36% YoY sales growth for IPTV/set-top boxes.

Maintain Outperform, lower target price to HK$12.80. We cut our FY16F-18F earnings forecasts 6-13% to reflect slower revenue growth from sales of telecom equipment and smartphones. Our new target price of HK$12.80, down from HK$17.10, is based on 12x 2016F P/E (previously 15x), one standard deviation below the three-year mid-cycle P/E valuation. We like ZTE for its leading position within the global telecom equipment industry and the traction it is gaining in government and corporate business. Following a price correction of 25% after the US incident, we see good value at the current price level.