TELECOMS: ZTE Back In Black As Turnaround Takes Hold

By newsdoug on January 20, 2015

Bottom line: ZTE’s latest preliminary results show the company may have turned a corner in the second half of last year and could be set for a business rebound if it can maintain focus on key new product and service areas.

A new profit report from ZTE (HKEx: 763; Shenzhen: 000063) is painting a cautiously upbeat picture about the telecoms giant as it emerges from a difficult period and tries to reposition itself as a specialist in networked systems and devices that talk to each other. The company’s report that its profit for 2014 nearly doubled from a year earlier certainly looks encouraging, though it probably includes many one-time items that make the figures less meaningful. A comparison with its last financial report from the third quarter is more meaningful and also looks mostly encouraging, showing operating profit and revenue growth were picking up even as net profitability appeared to be slowing.

These kinds of trends look mostly positive for a company like ZTE, which is in the midst of a relatively large transformation. Such transformations typically see costs jump as companies spend heavily on product development, which also requires big spending on promotion and cultivation of new sales channels. In ZTE’s case, the company has also posted a large number of one-time items over the last 2 years as it sold off assets and took charges as part of its restructuring.

That makes the company’s net profit often a meaningless figure, since that bottom-line figure includes many such non-recurring items. In this case ZTE said its net profit grew 94 percent to 2.64 billion yuan ($426 million) for all of 2014. (company announcement; Chinese article) By comparison, its net profit grew at a much faster 232 percent in the first 9 months of the year, meaning growth slowed sharply in the final quarter. But the net figures aren’t particularly revealing since they could contain many one-time items.

Far more revealing was ZTE’s operating profit and revenue, which provide a better picture of the company’s health as it marches into a new array of product areas from gaming consoles to smartphones. The company swung to a modest operating profit of 105 million yuan for the year, reversing a massive operating loss of 1.5 billion yuan in 2013. That compares with a consolidated operating profit of 29 million yuan in the first 9 months of last year, versus a restated loss of 1.5 billion yuan a year earlier.

I’ll admit I’m not 100 percent certain these 2 sets of figures are comparable, but the operating profit did appear to be accelerating in the fourth quarter as the company started to show benefits from its restructuring. Operating revenue was a bit clearer, rising 8 percent to 81 billion yuan for the full year. That marked a slight pick-up from the first 9 months of the year, when operating revenue rose 7.8 percent.

From a purely numbers perspective, these latest figures do seem to show that ZTE probably turned a corner in the third or fourth quarter of last year and is back on an upward track in terms of revenue and operating profit growth. But it’s also worth noting the company is placing big bets on the ultra-competitive smartphone business, and it’s far from clear that ZTE will survive as a major player when the dust settles from a bitter war now taking place in its home China market.

So, what’s ahead for this company as we head into the new year? When it announced its new branding campaign and broader strategy earlier this month, I said the new direction looked relatively good if it could maintain its focus on a few key product areas in the rapidly changing world of interconnected products and services. Such a strategy might ultimately mean having to abandon some of its mainstream products like the low-cost smartphones that could become a drag on its profits if ZTE isn’t careful. If it can maintain the focus and roll out new products and services in key areas that aren’t too competitive, it could extend its nascent recovery into 2015 and perhaps even see some upside in its stock that has largely languished for more than a year.