Tianfeng Securities issued a research report stating that it maintains a "buy" rating on Tencent (00700). The company's high gross margin rate incremental business has laid the foundation for continuous improvement in gross margin rate. The performance of domestic/overseas games implies an accelerated growth in game revenue in the second half of the year. The forecast for non-IFRS net income attributable to equity holders for 2024-2026 has been raised to 217.8/251.7/278.6 billion yuan (originally forecasted at 209.1/239.6/269.1 billion yuan) with year-on-year growth rates of 38%/16%/11% respectively. The target price is maintained at HKD 476.

Tianfeng Securities' main points are as follows:

Overall performance: Profit performance is excellent, and there may be further room for upward revision in market expectations.

In 2Q2024, the company's revenue increased by 8% year-on-year and 1% quarter-on-quarter, which is basically in line with institutional expectations. The non-IFRS operating profit in 2Q2024 increased by 27% year-on-year and remained flat quarter-on-quarter. The non-IFRS net profit increased by 53% year-on-year and 14% quarter-on-quarter, significantly exceeding the institutional expectations of 8.6 billion. The year-on-year growth rate of non-IFRS net income attributable to equity holders has exceeded 50% for two consecutive quarters, with a 2-year CAGR of 40% and 43% respectively.

In 2Q2024, the company's gross profit increased by 21% year-on-year and 2% quarter-on-quarter, with a gross margin of about 53.3%, up by 5.8 percentage points year-on-year and 0.7 percentage points quarter-on-quarter. The gross margin level is slightly better than institutional expectations. The company's management stated at the earnings conference that it expects the revenue structure to shift to a high gross margin business portfolio, which will be a long-term phenomenon. Gross profit growth will continue to outpace revenue growth, but as the marginal effects of efficiency measures diminish, the multiplier for gross profit growth may change from more than 2 times to 1-2 times the multiplier for revenue growth.

In 2Q2024, the growth rate of non-IFRS net profit far exceeded the growth rate of operating profit. This was partly due to: 1) In 2Q2024, the non-IFRS share of the company's joint venture operating profit increased by a net of 6 billion yuan year-on-year and 4.4 billion yuan quarter-on-quarter, mainly due to the improved performance of several domestic joint venture companies and overseas game studio joint venture companies. The company's management stated at the earnings conference that it expects a slowdown in the year-on-year growth of the share of joint venture operating profit in the second half of the year. 2) In 2Q2024, the company's income tax expenses decreased by 9% year-on-year, mainly due to a higher base in the same period of the previous year caused by a deferred income tax adjustment of a subsidiary company overseas. The company's management stated at the earnings conference that it expects the non-IFRS income tax rate for the full year 2024 to be between 18% and 20% (compared to 22% in 2023).

Looking at the second half of the year, the bank believes that Tencent's fundamentals will continue to exhibit two characteristics: higher gross profit growth driven by incremental business development and further improvement in game revenue growth. The current institutional expectations may still have room for upward revision.

Online games: In 2Q2024, the revenue recovered with higher growth, and it is expected that the revenue growth rate will continue to improve in the second half of the year.

In 2Q2024, the company's online game revenue growth rate recovered to 9% YoY, with both domestic and overseas game revenue growth rates also recovering to 9% YoY. 2Q2024 saw a recovery in revenue growth for both "King of Glory" and "Peacekeeping Elite", with both games maintaining a top 2 ranking on the iOS game sales chart after the launch of "Dungeon & Warrior: Origins" (according to data from Qimai). Domestic game revenue growth rate exceeded that of total revenue. In the overseas market, 2Q2024 saw a significant increase in the average daily active users of "Wild Combat", with revenue growth rate exceeding 10 times YoY. As of 2Q2024, the company's current liabilities-deferred revenue balance increased by 15% YoY, and the bank predicts that it will gradually be confirmed with revenue growth, leading to continuous improvement in game revenue growth rate in the second half of the year.

Online advertising: 2Q2024 revenue increased by 19% YoY, and the development path of the advertising business may provide growth resilience.

In 2Q2024, the company's advertising revenue increased by 19% YoY and 13% QoQ, surpassing institutional expectations. This growth was mainly driven by the increase in revenue from video platforms and long videos, partially offset by the decrease in advertising budgets of internet service industry advertisers and the decline in revenue from mobile alliances advertising. The gross margin of advertising in 2Q2024 increased by 36% YoY, continuing to improve to 56%. The company's current advertising business strategy is clear: 1) promote technological upgrades to improve conversion rates; 2) increase the proportion of closed-loop ads in the WeChat advertising portfolio; 3) gradually release more ad inventory. The bank predicts that the company's advertising business will have stronger resilience in the face of macroeconomic fluctuations.

FBS: Macroeconomic consumption environment leads to short-term slowing of fintech service revenue.

In 2Q2024, the company's fintech and enterprise service revenue increased by 4% YoY and decreased by 4% QoQ, lower than institutional expectations. The growth rate of fintech service revenue in the second quarter slowed to single digits, reflecting changes in consumer spending, while the company's strengthened risk control measures led to a decrease in consumer loan income. The YoY growth rate of enterprise service revenue in the second quarter reached double digits, benefiting from the growth of cloud computing service revenue (including the commercialization of WeChat for Enterprises) and the increase in technical service fees for video platforms.

Risk factors: Uncertainty in macroeconomic growth; Uncertainty in the launch of new games; Slower-than-expected commercialization pace of AI technology.