1H22 results miss our expectations

Digital China Information Service Company Ltd (DCITS) announced its 1H22 results: Revenue fell 9.9% YoY to Rmb4.44bn, attributable net profit declined 34.2% YoY to Rmb116mn, and recurring net profit decreased 44.8% YoY to Rmb91mn. In 2Q22, revenue slid 12.8% YoY to Rmb2.52bn, attributable net profit dropped 38.1% YoY to Rmb85mn, and recurring net profit fell 43.2% YoY to Rmb74mn. The firm’s 1H22 results missed our expectations, mainly due to the COVID-19 resurgence weighing on the firm’s on-site bidding and project deliveries in tier-1 cities.

Trends to watch

On-site bidding and deliveries of fintech projects under pressure from COVID-19 in tier-1 cities; upbeat on upgrades and demand for import substitution of bank IT products over long term. In 1H22, DCITS’ revenue from financial institutions, governments & enterprises, and operators reached Rmb2.05bn (+1.28% YoY), Rmb1.42bn (-14.72% YoY), and Rmb761mn (-24.90%YoY), mainly due to the adverse impact from COVID-19 resurgences on the firm’s business expansion and project bidding and deliveries.

Business with financial institutions. Financial software services: In 1H22, DCITS’s revenue from financial software services rose 11.49% YoY to Rmb1.1bn. The firm maintains a leading position in core banking systems, microservices platforms, and open banking systems, which has allowed it to win orders from key clients. Specifically, in 1H22 the total value of its orders from China’s six largest state-owned banks amounted to Rmb0.4bn (+26% YoY), with that from joint-stock banks rising 10% YoY. Moreover, the firm has secured orders from Postal Savings Bank of China and China Bohai Bank for its core banking IT systems. Financial software and hardware: In 1H22, the firm won Rmb760mn in orders (revenue recognized but products not yet delivered) for its financial software and hardware from clients such as Bank of China (over Rmb100mn), and provided a wide range of fintech solutions to several leading regional banks such as Bank of Beijing and Bank of Shanghai.

GM and net profit disappoint due to COVID-19 resurgence. In 1H22, the firm’s gross margin (GM) fell 0.5ppt YoY to 17.7% due to delayed project deliveries amid COVID-19. In 1H22, the selling and G&A expense ratios rose 0.3ppt and 0.2ppt YoY to 4.1% and 2.3% mainly because staff expenses remained fixed and deferred revenue recognition put profit margins under pressure. In 1H22, the R&D selling expense ratio rose 0.3ppt YoY to 5.6% on rising labor costs amid intense competition for high-quality financial technology professionals.

Demand for bank IT systems to remain strong; DCITS provides full-range fintech products and services to support bank digitalization. DCITS continued to upgrade its fintech product mix and solution offerings, enabling itself to maintain leadership in segments such as core banking systems. The firm strives to seize opportunities for growth backed by its one-stop service capability and partnerships with players in the fintech ecosystem such as Tencent. We remain upbeat on growing demand for upgrades and import substitution of bank IT systems. Thus, we see ample growth potential for the firm, bolstered by its leadership in high-quality products and solutions in the fintech industry.

Financials and valuation

Considering the COVID-19 resurgence has weighed on the firm’s project deliveries, we trim our 2022 and 2023 revenue forecasts 4.6% and 4.2% to Rmb11.76bn and Rmb13.10bn, and lower our attributable net profit forecast 11.1% to Rmb400mn for 2022 and 15.1% to Rmb446mn for 2023. We are upbeat on strong demand for banking IT systems and the firm’s long-term growth prospects. We maintain OUTPERFORM and our target price at Rmb14 (34x 2022e and 31x 2023e P/E), offering 30.6% upside. The stock is trading at 26x 2022e and 24x 2023e P/E.

Risks

Project deliveries and/or expansion of product lines disappoint; more intense competition in the banking IT system market.