Hikvision Announces Weakened Profits

Hikvision released a special announcement in Chinese, disclosing weakened profits for 2015 amid fierce competition.

In this note, we examine what happened with Hikvision, the underlying economic conditions and what this means for the Chinese government owned giant.

Announcement

In the announcement [link no longer available], Hikvision downwardly revised their net income margins for 2015. For the first 3 quarters of 2015 [link no longer available], Hikvision net income percentage increased ~39%, with an estimated full year range of 30-50%. Now, Hikvision says for the full year, net income increase will only be in the 25-35% range. Since they issued an announcement just for this, it underscores that this came as a (negative) surprise for them.

Hikvision's Q4 and full 2015 results have not yet been released. This announcement was primarily a warning, Hikvision typically releases annual results in March or April.

Causes

Hikvision cited two factors.

First economic / competitive:

"Due to the macro-economic environment and other factors, the domestic industry market project has been delayed, an increase of lower than expected; the fierce competition in the domestic market, gross margins declined" (emphasis added)

Secondly, a question about tax rate, that they are not sure whether they will be taxed at a 15% or 10% rate. Note: China's normal corporate tax rate is 25%, with tech companies paying 15% and evidently some companies like Hikvision getting a further tax cut down to just 10%. Hikvision did not explain why their tax rate might rise.

Huge Revenue Growth Slowing

For the first 3 quarters, Hikvision revenue grew 56.3%, which is absolutely amazing, both in terms of percentages and absolute dollars, given their already huge size. However, Q1 growth was 65% slowing to Q3 growth of 47%. Hikvision did not comment on Q4 growth. 

Profits Lagging Revenue Growth

While revenue is up 55%+, Hikvision now says profits are only going to grow about half that rate for 2015. Despite its growth and already tremendously large scale, Hikvision is becoming significantly less profitable. In their announcement, they emphasized profit challenges in their own domestic market, where they are most mature. We suspect they did not mention overseas since overseas still only represents a quarter of their business; however, given the much higher costs of running overseas operations and their reduced scale overseas, profits are surely still lower.

Their total profit margin for 2015, despite this downtrend, will still remain astronomically high for the video surveillance industry overall. Instead of their historic 25%+ net margins, Hikvision will likely start dipping into the 20-25% range.

China 'Macro-economic Environment'

China's economic downturn is a major issue. Even the Chinese government's PR agency, Xinhua, acknowledged today [link no longer available]:

"Falling industrial product prices, shrinking enterprise profits, waning fiscal revenue and rising financial risks...housing market is undoubtedly in bad shape"

Concluding:

"Of course there will be no miraculous V-shape economic recovery, but after painstaking structural reforms, the world can expect a more sustainable and vibrant Chinese economy."

All Chinese companies, government owned or not, are caught up in this. To that end, Hikvision's warning about the 'macro-economic environment' and 'fierce competition' are understandable. Indeed, with the economy as it is, and the smaller manufacturers (e.g., Shenzhen) struggling to stay afloat, Hikvision has its own domestic battle to handle.

Outlook

Though China faces immense problems (with debt, inefficient investment, the middle income trap, etc.), China and Hikvision still have immense reserves / resources to use (e.g., Hikvision's $3.1 billion).

One key question will be how much more stimulus / infrastructure investment will China continue. Hikvision has been a prime beneficiary of massive post 2008 stimulus spending. Many argue that the spending has been inefficient / wasteful but it has certainly boosted GDP growth and the rise of Chinese domestic companies. Will China continue with such levels of spending or will they shift more to a consumer led economy?

Hikvision has huge resources and ambitions but the slowing Chinese economy and the challenges of building a sustainable overseas business could be too much for them. 2016 is shaping up to be an interesting year for them and the industry.