2021 net profit misses our forecast: recurring net profit largely in line

Tongtech announced that revenue rose 34.8% YoY in 2021 results to Rmb863mn, attributable net profit grew 1.5% YoY to Rmb248mn, and recurring net profit increased 31.9% YoY to Rmb221mn. In 4Q21, revenue rose 7.2% YoY to Rmb471mn and attributable net profit dropped 10.2% YoY to Rmb210mn. Attributable net profit missed our forecast, as government subsidies for the firm dropped around Rmb60mn YoY in 2021. However, recurring net profit maintained sound growth, despite selling expenses jumping 107% YoY. Recurring net profit was largely in line with the market’s and our expectations.

Trends to watch

Middleware revenue continues rising; cash flow beats. Middleware revenue at Tongtech rose 24% YoY in 2021 to Rmb333mn from a high base in 2020. The firm continues servicing replacement of imported middleware products at governmental departments. Its business expansion in financial, operator, and high-end equipment markets advance smoothly. In 2021, revenue from middleware localization in the financial sector was around Rmb80mn.

Industries represented by the financial sector will keep localizing middleware products in our view and domestic products will continue penetrating into government agencies in counties in 2022. Thus, we expect the median of Tongtech’s middleware revenue to remain high in 2022. The firm also optimized its accounts receivable in 2021 and received payment from some governmental or enterprise projects in advance. Its operating cash flow jumped 107% YoY to Rmb255mn, beating our expectation.

Businesses such as security and digitalization services for government departments and enterprises developing; likely to be important revenue growth drivers. In 2021, Tongtech subsidiaries providing security and digital transformation services both saw revenue grow more than 30% YoY. In the early 2022, the firm became a smart security solution supplier for the 2022 Winter Olympics and won bids for a large-scale smart emergency and security projects in Anhui province. It also made breakthroughs in the field of public security in 2021. We believe that its security solutions and digitalization businesses will likely grow faster than market expects, bolstering the firm’s rapid revenue growth.

Financials and valuation

COVID-19 has affected the delivery of security projects. We also see uncertainties in its business related to import substitution. Thus, we cut our 2022 and 2023 revenue forecasts 6% and 9% to Rmb1.15bn and Rmb1.49bn, and lower our 2022 and 2023 net profit forecasts 10% and 13% to Rmb434mn and Rmb592mn. We maintain OUTPERFORM, but as the median of the sector valuation has fallen we lower our valuation to 28x 2022e and 21x 2023e P/E, and cut our target price 31% to Rmb27, offering 38% upside. The stock is trading at 21x 2022e and 15x 2023e P/E.

Risks

Disappointing progress in import substitution; intense competition.