1H22 earnings slightly miss our expectation

Tungkong announced its 1H22 results: Revenue fell 16.3% YoY to Rmb503mn, net profit attributable to shareholders declined 13.4% YoY to Rmb78mn, and recurring net profit attributable to shareholders dropped 12.1% YoY to Rmb73mn. The company's earnings slightly missed our expectations due to the worse-than-expected impacts of COVID-19 resurgence on its traditional business.

The company’s revenue fell 0.9% YoY to Rmb301mn in 1Q22 and declined 32.0% YoY to Rmb202mn in 2Q22, and its net profit attributable to shareholders rose 2.6% YoY to Rmb45mn in 1Q22 but fell 28.8% YoY to Rmb33mn in 2Q22.

Trends to watch

Printing business under pressure; service business growing steadily. Tungkong's revenue dropped 16.3% YoY in 1H22. 1) Printing products: Tungkong's revenue from printing products fell 25.6% YoY to Rmb345mn in 1H22, possibly because some customers cancelled or postponed procurement or orders for products due to COVID-19 resurgence in 1H22, and demand for paper documents such as paper invoices and certificates decreased amid the trend of electronic invoices and bills. 2) Technological services: The company's revenue from technological services grew 11.8% YoY to Rmb86mn in 1H22, with the electronic documents and archives storage business and electronic invoice business growing robustly. 3) Other businesses: Tungkong's revenue from laminated products rose 2.6% YoY to about Rmb50mn in 1H22, and its revenue from lottery tickets via new channels grew rapidly YoY.

Profitability remains stable. Tungkong’s overall gross profit margin increased by 0.75ppt YoY to 40.66% in 1H22, mainly thanks to declines in prices of upstream paper products. The gross profit margin of the company's printing products rose 3.3ppt YoY to 39.29% in 1H22, while that of its laminated products decreased by 16.7ppt YoY to 33.5% due to increases in prices of upstream chips. In 1H22, the company’s selling expense ratio fell 2.2ppt YoY to 5.2%, but its G amp;A expense ratio, financial expense ratio, and R amp;D expense ratio rose 1.8ppt, 0.03ppt, and 0.8ppt to 8.4%, -0.05%, and 7.3%. The company further increased R amp;D investment. Thanks to rising gross profit margin, the company’s net margin (based on net profit attributable to shareholders) rose 0.52ppt YoY to 15.5% in 1H22.

Optimistic about the growth potential of new businesses such as electronic invoice and electronic storage; pay attention to possible recovery in traditional business. 1) Electronic invoices: Such products are environmentally friendly, highly resistant to counterfeiting, and can be stored and queried conveniently, and they have reported rapid growth amid the popularity of mobile payment and e-commerce in recent years. Thanks to its expertise and customer advantage in traditional paper invoices and certificates, Tungkong is making forward-looking efforts to expand its presence in electronic invoices to facilitate its business transformation. 2) Electronic storage: Electronic archive storage has become a clear industry-wide trend in recent years. Tungkong Ruiyun (a subsidiary of Tungkong) focuses on the electronic archive storage business, and it has expanded its presence in a number of major cities in China. We believe the development of these new businesses could facilitate Tungkong’s transformation into an information technology services provider.

Financials and valuation

Due to worse-than-expected impacts from COVID-19 resurgence, we lower our 2022 and 2023 revenue forecasts by 10.9% and 10.6% to Rmb1.11bn and Rmb1.19bn, and cut our 2022 and 2023 EPS forecasts by 16.0% and 9.5% to Rmb0.32 and Rmb0.37. The stock is trading at 24x 2022e and 21x 2023e P/E. Maintain OUTPERFORM. We are revising our earnings forecasts downward, but we do not expect the impact from COVID-19 to be as strong in 2H22. As such, we lower our target price by 8% to Rmb8.82 (27x 2022e and 24x 2023e P/E), offering 15% upside.

Risks

Volatile raw material prices; disappointing expansion of new businesses.