Recently, leading communications equipment vendor ZTE (000063.SZ) unveiled a disappointing 2024 financial report, with its net profit in Q4 plummeting by over 60%.

According to Stockstar, under the strain of dwindling profitability, ZTE, long known for its emphasis on R&D, joined the cost-cutting trend but failed to reverse the profit slide. Meanwhile, the company's foundational carrier business declined due to reduced carrier investments, while the incremental growth from its enterprise and consumer businesses was insufficient to offset the carrier business's decline. Additionally, the enterprise business, which held high promise for ZTE, witnessed a significant drop in gross profit margin before it could become a significant revenue driver.

01. Poor Performance: Cost Reduction Fails to Boost Net Profit

The annual report reveals that ZTE achieved revenue of RMB 121.299 billion in 2024, a year-on-year decrease of 2.38%, and net profit attributable to shareholders of RMB 8.425 billion, a year-on-year decline of 9.66%. This marks the first time since 2019 that ZTE has seen declines in both revenue and profit.

Specifically, the company generated revenue of RMB 31.254 billion in Q4, a year-on-year decrease of 10.34%; net profit attributable to shareholders was RMB 518 million, a year-on-year drop of 65.08%, and non-GAAP net profit was -RMB 719 million, transitioning from profit to loss year-on-year. ZTE has now experienced declines in both revenue and profit for two consecutive quarters.

Further analysis shows that software tax rebates contributed over 20% of ZTE's profits in 2024.

In 2024, due to increased benefits from the VAT additional deduction policy and heightened VAT rebates for software products, the company's other income surged by 62.39% year-on-year to RMB 2.933 billion, accounting for 35% of the company's net profit for the period, up from 24% in the same period last year.

Among these, the company's income from VAT rebates for software products amounted to RMB 2.069 billion, a year-on-year increase of 45%, representing 25% of net profit for the period.

Stockstar notes that, amidst declining performance, the company embarked on cost-cutting measures. ZTE's R&D expenses, administrative expenses, and selling expenses all declined to varying degrees, to RMB 24.031 billion, RMB 8.901 billion, and RMB 4.477 billion, respectively, with year-on-year decreases of 4.97%, 12.05%, and 20.5%.

Historically, high R&D investment has been a hallmark of ZTE. Since 2019, the company's R&D expenses have continually risen, from RMB 12.548 billion in 2019 to RMB 25.289 billion in 2024, with its R&D expense ratio increasing from 13.83% to 20.53%.

Regarding the decrease in R&D expenses in 2024, the company attributed it to a focus on high-potential and strategic R&D projects to achieve precise resource allocation. Concurrently, the company's R&D personnel decreased from 35,400 in 2023 to 33,200, a reduction of over 2,000 individuals.

Evidently, cost reduction efforts failed to salvage the company from its profitability decline. Moreover, compared to 2023, while the company's global patent applications and cumulative global authorized patents increased, its ranking in the number of valid 5G standard essential patent families declined. As a crucial indicator reflecting a company's innovation capability and market competitiveness in the 5G technology domain, ZTE's ranking slipped from fourth globally in 2023 to fifth.

Additionally, under the pressure of waning profitability, ZTE's cash flow situation deteriorated. In 2024, the company's net cash flow from operating activities was approximately RMB 11.48 billion, a year-on-year decrease of 34.05%. This change was primarily due to an uptick in cash payments for goods purchased and services received, along with an increase in the statutory reserve ratio of ZTE Group Finance Co., Ltd.

02. Hidden Concerns in Major Businesses: Gross Profit Margin Plummets in International Market

As a leading communications equipment vendor, ZTE's business encompasses a comprehensive range of end-to-end products and integrated solutions in the ICT industry, spanning wireless, wired, computing power and energy, and terminals. Based on customer segmentation, the company divides its operations into three primary segments: carrier networks, enterprise business, and consumer business.

Stockstar observes that the carrier segment, being the company's core business, witnessed a revenue decline due to the slowdown in carrier market investments.

As of the end of 2024, China had established over 4.25 million 5G base stations. With the gradual completion of base station construction, carriers' investment strategies are shifting, placing greater emphasis on the maintenance and upgrade of existing networks rather than the large-scale deployment of new base stations. Consequently, 5G-related expenditures in the capital expenditures of the three major carriers have commenced to decline.

Stockstar points out that since 2024, 5G infrastructure has entered the post-construction phase, leading to a decline in 5G-related expenditures in the capital expenditures of the three major carriers. As the carrier segment forms the backbone of ZTE's business, the reduction in carrier capital expenditures poses challenges to the growth of ZTE's carrier segment. In 2024, the carrier network business generated revenue of RMB 70.3 billion, accounting for 57.98% of total revenue, with a year-on-year decrease of 15%.

Although ZTE has demonstrated growth momentum in its enterprise and consumer businesses, the incremental growth of these segments is limited and struggles to compensate for the impact of the carrier network business's decline.

It's worth noting that ZTE's current main development strategy is to maintain the core competitiveness of its first-curve business, primarily wireless and wired products, while accelerating the expansion of its second-curve business, represented by computing power solutions such as servers and storage. Therefore, the enterprise business, encompassing server and storage product lines, is viewed as the future growth pillar of ZTE.

In 2024, fueled by the growth of server and storage businesses, the company's enterprise business generated revenue of RMB 18.566 billion, a year-on-year increase of 36.68%, accounting for 15.3% of total revenue. Among the company's three primary businesses, this segment had the lowest revenue share.

Moreover, in 2024, the gross profit margin of the enterprise business plummeted, from 34.94% to 15.33%, a year-on-year decrease of 19.58 percentage points, effectively "halving." The company attributed this decline to the drop in the gross profit margin of servers and storage, as well as changes in the revenue structure. Precisely because of the significant decrease in the enterprise business's gross profit margin, the company's overall gross profit margin stood at 37.91%, a year-on-year decrease of 3.62 percentage points.

In the consumer business segment, which includes home terminals and mobile phones, ZTE set a goal in 2020 to "return ZTE mobile phones to first-tier brands within the next five years." It is reported that in 2024, the company launched several new mobile phone products, including the latest flagship nubia Z70 Ultra and the Red Magic 10 Pro series. Notably, Red Magic phones enjoy high popularity and reputation among gamers but have a relatively narrow audience.

According to Canalys' data on smartphone shipments in the Chinese mainland market in 2024, the top five brands in market share were vivo, Huawei, Apple, OPPO, and Honor, with ZTE's brands classified under "Others." Evidently, the company failed to achieve its goal of reclaiming first-tier brand status.

By market, ZTE's domestic and international performances diverged in 2024. The company's domestic business was impacted by pressure on the carrier network, with domestic revenue of RMB 82.006 billion, a year-on-year decrease of 5.18%, accounting for 67.61% of total revenue.

Regarding the international market's performance, the company mentioned in its annual report that revenue from international carrier networks and mobile phone products both increased. In 2024, the company's international market revenue was RMB 39.293 billion, a year-on-year increase of 4.04%, accounting for 32.39% of total revenue. Nonetheless, the gross profit margin of the company's international market also declined markedly. In 2024, the company's international market gross profit margin was 26.91%, a year-on-year decrease of 10 percentage points and significantly lower than the domestic market's 43.18%.

Currently, the company's international market primarily targets Asia (excluding China), Africa, Europe, America, and Oceania. In 2024, the gross profit margins of these regions all declined, to 29.16%, 34.06%, and 22.3%, respectively, with year-on-year decreases of 9.89 percentage points, 20.57 percentage points, and 7.73 percentage points. (This article was originally published on Stockstar, authored by Li Ruohan)

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