Surviving China’s telecom equipment shakeout
Initiate coverage with a Buy 2 rating We initiate coverage of ZTE Corporation (Zhongxing Telecom Equipment) with a Buy 2 rating and a price target of Rmb22.91. Following several strong years of growth and an accompanying shakeout in the Chinese telco infrastructure industry, we believe ZTE is well placed to consolidate its position as a leading domestic equipment vendor.
Glory days may be over, but profits still there Although we forecast revenue growth to slow significantly in 2002 (9% relative to 2001's 106%) and net income to decline 14% YoY, ZTE is still profitable and is likely to remain so, in our view.
ZTE best placed to succeed relative to its domestic peers The telco equipment sector in China is undergoing a shakeout as competition intensifies. Only those vendors with close technical links to the carriers and established product lines will prosper in our view. Relative to its domestic peers, we consider ZTE to be the best placed vendor to succeed in the long term.
Valuation: DCF valuation uses conservative assumptions We value ZTE at Rmb22.91/share using a traditional DCF approach. Our WACC assumes a cost of equity of 8.56% and a cost of debt of 6% with an 11:89 longterm debt/equity assumption. We consider these conservative assumptions. Our 12-month price target is 32% above current levels.