ZTE (00763): ZTE's strong revenue growth is being offset by product-mix pressure on margins

Overview

Goldman Sachs reviews ZTE's 2Q26 results and finds a sharp contrast between stronger-than-expected revenue and weaker profitability. Enterprise, government and AI infrastructure growth supports the longer-term outlook, but adverse product mix and slow Chinese telecom capital expenditure led to lower margin, earnings and valuation assumptions. Neutral is maintained on both share classes.

Core views

ZTE's 2Q26 revenue reached Rmb43.037bn, up 12% YoY and 23% QoQ and 8% above Goldman Sachs' Rmb39.792bn estimate. The report attributes the beat principally to enterprise and government business, whose 1H26 revenue grew 44% YoY. This expansion shows that businesses outside the traditional operator market are becoming a more important growth engine. Profitability, however, was substantially weaker. Overall gross margin was 23.2%, down 7.7 percentage points YoY and 5.1 percentage points QoQ and versus Goldman Sachs' 28.3% estimate. The report links this mainly to product-mix changes in the operator network business, whose 1H26 gross margin fell 15 percentage points YoY. Operating expenses were better controlled than expected, with the 2Q26 expense ratio at 21.6%, but that efficiency was insufficient to offset the gross-margin decline. Operating profit was Rmb691mn, 61% below estimate, down 56% QoQ and 58% YoY; operating margin fell to 1.6%. Net income was Rmb1.442bn, up 10% QoQ but down 45% YoY and 11% below estimate. Goldman Sachs therefore raises its revenue outlook while reducing its profitability assumptions. The firm increases 2026E/2027E/2028E revenue estimates by 3%/5%/7% to Rmb160.500bn/Rmb180.711bn/Rmb202.031bn, mainly because it expects a larger contribution from AI infrastructure. Conversely, gross-profit estimates fall 9%/10%/6%, operating-income estimates fall 24%/16%/8%, and net-income estimates fall 6%/10%/2% to Rmb7.111bn/Rmb8.180bn/Rmb9.416bn. Revised gross margins are 25.5%/25.2%/25.0%, reductions of 3.6/4.1/3.5 percentage points from prior forecasts, while revised operating margins are 3.9%/4.2%/4.5%. The report also lowers projected expense ratios to 21.6%/21.0%/20.6%, reflecting operating leverage as revenue scales, but this does not fully compensate for the weaker gross-margin outlook. Revised net margins are 4.4%/4.5%/4.7%. Strategically, the report remains positive about ZTE's long-term growth even as slow Chinese telecom capital expenditure pressures the traditional operator business. ZTE is expanding into 6G, T-bit optical networks, 200G PON and AI computing infrastructure. Overseas, it is supporting mobile-network 5G upgrades and broadband fiber transformation while deepening cooperation in wireless communications and fiber broadband. Goldman Sachs expects computing profitability to improve as the business gains scale and views this second growth curve as the basis for sustainable longer-term expansion. The earnings cuts lead directly to lower valuation targets. For the H-share, Goldman Sachs cuts its 12-month target price by 13% to HK$32.60 from HK$37.50 and reduces the target multiple to 17.5x 2027E P/E from 18.2x. That multiple is derived from the relationship between telecom peers' average 2027-28E earnings growth and their 2027E P/E. Against the HK$22.44 closing price on 25 September 2026, the target represents 45.3% upside. For the A-share, the 12-month target also falls 13%, to Rmb50.6 from Rmb58.2. It is based on 29.6x 2027E P/E, down from 30.8x, using an unchanged 69% valuation premium over the H-share and a CNY/HKD exchange rate of 1.09. Goldman Sachs considers the A-H premium approach more stable than relying on the A-share's historical average trading multiple. Despite the stated H-share upside and positive long-term computing view, the institution maintains Neutral on both ZTE-A and ZTE-H because near-term margin and earnings pressure offsets the stronger growth profile.

Analysis framework

Goldman Sachs first compares ZTE's 2Q26 revenue, margins and earnings with its estimates and prior-year and prior-quarter results. It then traces the revenue beat to enterprise and government growth and the earnings miss to operator-network product mix. Those findings are incorporated into 2026-28 forecasts for revenue, margins, expenses and earnings. Finally, the revised earnings are translated into separate H-share and A-share targets using peer growth-versus-P/E relationships and an A-H valuation premium.

Methodology notes

• Valuation methodsP/E and PEG Valuation

  Peer growth-to-P/E valuation with an A-H premium

  The H-share target multiple is based on the relationship between telecom peers' average 2027-28E earnings growth and 2027E P/E. The A-share multiple applies an unchanged 69% premium to the H-share valuation and uses a CNY/HKD exchange rate of 1.09.

• Corporate Fundamentals and Finance

  Normal earnings power excluding non-operating gains and losses

  Goldman Sachs excludes non-operating gains and losses from its estimates to focus on recurring earnings power. Historical non-operating items ranged from a Rmb11bn loss to a Rmb1.9bn gain, so future occurrences could produce upside or downside to estimates.

Asset mapping & comparison

Structured mapping from thesis to named assets (strengths, weaknesses, peers, risks).

• ZTE H-share (00763.HK)

  Primary covered security; Goldman Sachs maintains Neutral and sets a 12-month target of HK$32.60.

  Strengths

  Enterprise and government growth, expanding AI infrastructure exposure and an expected improvement in computing profitability as the business scales.

  Weaknesses

  Operator-network product mix, slow Chinese telecom capital expenditure and a sharp 2Q26 gross-margin decline.

  Comparison

  Valued at 17.5x 2027E P/E using the relationship between telecom peers' 2027-28E earnings growth and 2027E P/E.

  Risks

  Telecom and 5G infrastructure demand, Chinese market-share gains, margin improvement and non-operating items may differ from expectations.

• ZTE A-share (000063.SZ)

  Covered share class; Goldman Sachs maintains Neutral and sets a 12-month target of Rmb50.6.

  Strengths

  Shares ZTE's enterprise, government, overseas-network and AI computing growth opportunities.

  Weaknesses

  Shares the company's operator-network margin pressure and reduced 2026-28E earnings outlook.

  Comparison

  Valued at 29.6x 2027E P/E, reflecting an unchanged 69% premium to the H-share multiple and a 1.09 CNY/HKD exchange rate.

  Risks

  Telecom and 5G infrastructure demand, Chinese market-share gains, margin improvement and non-operating items may differ from expectations.

Key data

• 2Q26 revenueRmb43.037bnUp 12% YoY and 23% QoQ; 8% above Goldman Sachs' estimate
• 1H26 enterprise and government growth44% YoYIdentified as the main driver of the revenue beat
• 2Q26 gross margin23.2%Down 7.7ppts YoY and 5.1ppts QoQ; 5.1ppts below estimate
• Operator network gross-margin change-15ppts YoY1H26 decline attributed mainly to product-mix change
• 2Q26 operating profitRmb691mn61% below estimate, down 56% QoQ and 58% YoY
• 2Q26 net incomeRmb1.442bnDown 45% YoY, up 10% QoQ and 11% below estimate
• 2026-28E revenue revisions+3%/+5%/+7%Raised mainly for greater AI infrastructure contribution
• 2026-28E net-income revisions-6%/-10%/-2%Reduced mainly because of lower gross-margin assumptions
• Revised 2026-28E revenueRmb160.500bn/Rmb180.711bn/Rmb202.031bnGoldman Sachs' new annual forecasts
• Revised 2026-28E net incomeRmb7.111bn/Rmb8.180bn/Rmb9.416bnGoldman Sachs' new annual forecasts
• Revised 2026-28E gross margin25.5%/25.2%/25.0%Down 3.6/4.1/3.5ppts from prior estimates
• H-share valuationHK$32.60 at 17.5x 2027E P/ETarget reduced 13% from HK$37.50; 45.3% above the HK$22.44 reference price
• A-share valuationRmb50.6 at 29.6x 2027E P/ETarget reduced 13% from Rmb58.2; incorporates a 69% A-H P/E premium and 1.09 CNY/HKD

Impact & implications

The report concludes that ZTE is gaining a stronger revenue-growth engine from enterprise, government and AI infrastructure activities, but its earnings conversion is being constrained by operator-network product mix and slow Chinese telecom capital expenditure. Scale-driven expense efficiency and improving computing profitability may support future margins, yet the current gross-margin pressure warrants lower earnings estimates and target prices, leaving Goldman Sachs at Neutral.

Risks

• Demand for telecom infrastructure and 5G base-station construction in China could be faster or slower than expected.
• ZTE's market-share gains in China could be faster or slower than expected.
• Margin improvement could occur faster or slower than expected.
• Future non-operating gains or losses could move earnings above or below estimates; historically these items ranged from a Rmb11bn loss to a Rmb1.9bn gain.

What to watch

• Track the pace of Chinese telecom capital expenditure and 5G base-station construction.
• Monitor whether ZTE gains market share in China faster or slower than expected.
• Watch operator-network product mix and the timing of gross-margin recovery.
• Track AI infrastructure growth and whether computing profitability improves with scale.
• Monitor any non-operating gains or losses excluded from Goldman Sachs' base estimates.