Dahua FY20 revenue grew at mere 1% YoY to RMB26.5bn as channel sales in China -30% YoY despite +8% YoY in overseas business. GPM and cash flow continued to improve but these might not be sustainable in FY21E as 1) FY20 GPM improvement was due to COVID-19 related thermal camera sales in 1H20 and 2) better cash conversion was driven by longer DPO but not shorter DSO. We maintain our view that Dahua’s AI technology gap with Hikvision will result in slower “To B” business growth amid AI deployment.
- GPM increase may not be sustainable in FY21E. Dahua delivered in-line FY4Q20 results with revenue growth of +6% YoY to RMB10,300mn but net profit dropped 18% YoY to RMB1,078mn. Dahua 4Q20 gross margin declined 2.3 pct pts YoY to 39.1% was a negative surprise (last time GPM <40% was in 1Q19). We attribute the margin drag to 1) more testing and delivery work for “To G” projects in 4Q20 and 2) weaker channel sales (FY20 revenue -30% YoY) and margin (GPM -4.4 pct pts to 25.9%). We believe FY20 margin improvement (GPM +1.6 pct pts YoY to 42.7%) was largely due to higher thermal camera sales to overseas market in 1H20 (FY1H20 overseas GPM: 57%) and such increment may not be sustainable in FY21E.
- Cash flow improved but not driven by shorter DSO. Operating cash flow in FY20 increased by 175% YoY to RMB4,402mn, compared to RMB1,600mn in FY19. Cash conversion ratio was at 1.13, the first time exceeding 1 in the past 10 years. However, we noticed that the cash flow improvement is largely driven by extending account payable days (123 in FY20 vs. 109 in FY19) rather than shortening days sales outstanding (182 in FY20 vs. 180 in FY19).
- Increasing R&D to capture AI opportunities. Dahua disclosed revenue and gross margin breakdown by product and customer segment for the first time. Dahua showed a similar pattern as Hikvision that its “To B” segment grew strongly at +24% YoY in FY20 amid COVID-19. This is in-line with our view that AI has led to diversified camera use cases rather than just public security (“To G” business). In FY20, Dahua increased R&D to RMB3bn (+11.3% YoY) and its AI R&D team size has exceeded a thousand people.
- Maintain HOLD. We largely maintained our FY21-22E revenue and net profit forecast. We slightly raised our target price to RMB25.42 (prior RMB25.35) on unchanged 17x FY22E P/E, in-line with its three-year mean.
