EUR 850.00 For Business Accounts Only

Morningstar | Hikvision’s Long-Term Sales Growth Continues to Be Underestimated by the Market; Shares Undervalued

Hangzhou Hikvision Digital Technology ’s mid-year 2019 earnings came in slightly ahead of our expectations and above the midpoint of management’s guidance. We raise our fair value to CNY 40.50 from 38.50 per share, as we increase our long-term revenue growth for the "others" business segment, which is made up of ancillary products such as alarm access control, to 15.7% CAGR from 8.2%. Following a strong 24% annual growth in 2018, the sale of ancillary products continued its strong momentum with a 39% year-over-year growth in the first half of the year, which is above our expectation of 8.0% growth. Hence, we have adjusted our 2019 sales growth for the segment upwards to 30.0%. Over the longer term, we believe demand for ancillary products should continue to grow resiliently as enterprise clients increasingly look beyond traditional surveillance and toward solutions that help to improve operational efficiency. We think the shares are undervalued and consider this an attractive entry point for investors.

Since the news in late May that Hikvision may be the target of a U.S. technology-supply ban, Hikvision’s share price has been range-bound because the market is concerned about the effect of the ban on Hikvision’s access to key chip-related technology and uncertainty about the timing of the firm’s growth recovery. We believe the market has overreacted to the first concern and the midyear results should alleviate investors' concerns about the near-term recovery.

Following a sluggish 6.2% year-over-year revenue growth in the first quarter, second-quarter top-line growth rebounded strongly to 21.5%, as management cited a recovery in the domestic market. We expect this recovery to continue into the third quarter of the year as growth in fixed asset investment has accelerated to 5.8% between January and June from 5.6% in the first five months. Furthermore, management said the demand from government and small-medium businesses has stabilized, and they are comparatively optimistic about demand from enterprise clients. Lastly, management has guided toward a 14.9% year-over-year net income growth in the third quarter at the midpoint (versus 15.0% in the second quarter). We expect sales growth, rather than operating margin expansion, to be a main driver of net income growth in the third quarter, as the tailwind to margin from a value-added tax reduction in the second quarter is behind it.

Despite the near-term headwinds in the overseas business, which grew 10.3% year over year in the first six months of 2019 and lagged the domestic business’s growth of 16.5%, we continue to like the long-term fundamentals of the company and our forecasts have baked in the spillover effect of the ban on Hikvision’s products to U.S. government entities. In the medium term, we expect softness in the overseas business to be offset by market share gains in the domestic market, which continue to make inroads in the solution offerings. Software-related business, which is often bundled with surveillance hardware and offered as a total solution, grew a healthy 25% year over year in the first six months of 2019. More importantly, Hikvision said enterprise clients are increasingly looking beyond traditional surveillance offerings and toward solutions that help to increase the operational efficiency of their business. We believe this new area of growth should help offset the growth deceleration in the public business group, which is made up of government entities and is well penetrated. Therefore, as enterprise clients seek solutions that help to improve their operational efficiency, the long-term demand for complementary products such as network access control, alarm, and video intercom should receive a boost.

In overseas markets, we believe that Hikvision faces an uphill battle to win orders in developed Western markets because of national security concerns. However, over the longer term, we think Hikvision will be able to leverage its scale in domestic market to keep prices competitive in developing markets, particularly Asia. Hikvision said it has seen strong demand from countries such as Vietnam, Philippines and India, where public security infrastructure continues to be expanded.