Dahua:3Q17results missed on rising expense and non-ops

3Q17EPS of RMB0.16

    Dahua reported 3Q17EPS of RMB0.16, which was 12% below the DB forecastof RMB0.18on rising selling expenses and higher finance costs. We maintainour Buy rating and TP of CNY27.5.

    Higher selling expense and non-op loss impact on 3Q17profit

    Dahua’s 3Q17revenue and gross profits were in line with the DB forecast, but3Q17operating profits were 9% below, at RMB359m, -49% QoQ/+72% YoY,mainly due to a higher selling expense ratio, at 15%. Moreover, the non-opprofits were below our forecast, as the recurring income from the VAT taxreturn was offset by a surge in finance expense from forex losses. While 3Q17pre-tax income was 24% below the DB forecast, on rising expenses and lowernon-op, Dahua incurred a tax credit of RMB28m, as with the RMB32m taxcredit in 3Q16. 3Q17net income was 12% below the DB forecast at CNY461m,-34% QoQ/+28% YoY, for EPS of CNY0.16. For 1-3Q17, net profit registeredCNY1.4bn, within management guidance of CNY1.3-1.5bn

    2017full-year guidance on profit growth at 20-40%

    Management gave 2017full-year guidance of annual profit to grow 20-40%YoY, with the range of net profit at CNY2.2bn-2.6bn. We note that the newguidance is lower than the raised 25-45% guidance for 1-3Q17profit growthgiven out in August 2017. The lower guidance could potentially be a reflectionof the lower non-op income. As we enter the peak season in 4Q17, we expectrevenue to grow 26% QoQ/59% YoY, while operating margin recovers fromscale. Our 2017full-year profit forecast of RMB2.5bn, for EPS of RMB0.87, isat the high-end of management’s guidance.

    Positive 2018outlook with accelerated profit growth

    We expect the strong revenue growth momentum to sustain into 2018as thecompany continues to expand market share with rising total solution projects.In addition, the AI applications and future PPP projects are catalysts to driveDahua’s growth outlook. In particular, Dahua has indicated participation inAlibaba’s “City Brain” project in providing infrastructures such as front-endsensors, back-end storage and access platforms. We expect OPM to sustain atthe 2017level of 12%, with a rising solution contribution and increasing scale.

    Valuation and risks

    As the 3Q17miss was mainly due to the rising selling expense and lower nonopincome, we lower our 2017earnings by 7% but leave our 2018forecastunchanged. We remain positive on Dahua and our TP is unchanged atCNY27.5, based on 22x FY2018E PE, supported by accelerated profit growth of38%/43% in 2017/2018and ROE expansions. Risks: market share loss andweak orders from solution projects.