ZTE's Server Business Drives Growth, but Product-Mix Changes Prolong Gross Margin Headwinds

Overview

This report reviews ZTE's results for 1H26 and the second quarter and provides an outlook for the second half. Nomura's core view is that demand for servers and storage equipment is driving revenue growth, but the rapidly rising share of the low-margin server business has prevented the revenue recovery from translating into a corresponding improvement in profit; constraints on capital expenditure by domestic carriers will also continue to exert pressure.

Core views

ZTE announced its 1H26 results after market close on August 21, 2026. According to the report, first-half revenue increased 6% YoY, with second-quarter revenue up 12% YoY and 23% QoQ. First-half profit declined 46% YoY to RMB2.753 billion, while second-quarter profit was RMB1.442 billion, down 45% YoY and up 10% QoQ. Operating cash flow declined 110% YoY to negative RMB126.6 million. Nomura believes that the coexistence of revenue growth and profit contraction was driven primarily not by a broad-based deterioration in demand, but by an unfavorable change in the product mix. The product mix is the key issue in the current results. The low-margin server business grew significantly faster than traditional businesses, causing the 1H26 gross margin to decline 7.0 percentage points YoY to 25.5%. The second-quarter gross margin fell further to 23.2%, down 7.7 percentage points YoY and 5.1 percentage points QoQ. Second-quarter gross profit was RMB9.991 billion, down 16% YoY and up only 1% QoQ, significantly lagging revenue growth. This indicates that incremental server revenue supported scale expansion but contributed relatively little to profit. The second-quarter net margin was 3.4%, down 3.4 percentage points YoY and 0.4 percentage points QoQ. By segment, revenue from the carrier network business declined 9% YoY in 1H26. Nomura mainly attributes this to persistent pressure in China's telecommunications market and believes growth in the overseas telecommunications business can only partially offset domestic weakness. Revenue from the government and corporate business increased 44% YoY in the first half, making it the main source of growth, driven by solid demand from data center customers for servers and storage equipment. Consumer business revenue increased 8% YoY in the first half, supported by growth in handsets and mobile internet products. This indicates that the company's growth focus is shifting toward businesses such as government and corporate servers, but this change is simultaneously reducing the overall gross margin. Looking ahead to 2H26, Nomura expects the domestic carrier business to continue facing challenges because domestic telecommunications carriers remain focused on controlling capital expenditure. On the other hand, the report expects AI server momentum to continue, with accelerating AI infrastructure investment by leading Chinese cloud service providers potentially supporting a recovery in ZTE's revenue growth. The two forces work in opposite directions: AI server demand benefits revenue, while weak domestic carrier demand and the rising share of low-margin products mean margin pressure will persist. Therefore, a revenue recovery does not equate to a simultaneous recovery in profitability. Based on its view that growth and margin pressure will coexist, Nomura maintains its Neutral rating on ZTE and its target price of HKD 39. The target price is based on 19x forecast FY2026 P/E and forecast EPS of RMB1.88. The report states that this multiple is consistent with the company's forecast earnings CAGR for FY2025-FY2027. Based on the share price of HKD 23.86 on August 21, 2026, the company was then trading at 11.6x forecast FY2026 P/E. Nomura uses the Hang Seng Index as its benchmark, and a Neutral rating means the share price is expected to perform broadly in line with the benchmark over the next 12 months.

Analysis framework

Nomura first compares changes in revenue, profit, cash flow, and margins for the first half and second quarter, then breaks down the sources of growth across the carrier network, government and corporate, and consumer businesses. It subsequently attributes the gross margin decline to the rising share of the low-margin server business and assesses the second-half revenue and margin outlook by considering domestic carrier capital expenditure and AI infrastructure investment by leading cloud service providers. Finally, it determines the target price using forecast FY2026 EPS and a P/E multiple.

Methodology notes

• Valuation MethodPE/PEG valuation

  Forward P/E Valuation

  The report derives a target price of HKD 39 by applying a 19x forecast FY2026 P/E multiple to forecast EPS of RMB1.88, using the forecast FY2025-FY2027 earnings CAGR as a reference for the multiple.

• Company Fundamentals and Financial Framework

  Segment Revenue and Product-Mix Analysis

  The report separately examines the revenue performance of the carrier network, government and corporate, and consumer businesses, and uses the rising share of low-margin servers to explain why gross margin and profit declined despite revenue growth.

• Industry/Sector Analysis FrameworkUpstream-Midstream-Downstream Industry Chain Transmission

  Transmission of Downstream Capital Expenditure to Equipment Demand

  The report links capital expenditure controls by domestic telecommunications carriers to weakness in the carrier network business, while associating accelerating AI infrastructure investment by leading cloud service providers with server demand and the company's revenue recovery.

Asset mapping & comparison

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

• ZTE (0763.HK)

  AI server and storage demand supports revenue growth, but weak domestic carrier demand and the rising share of low-margin servers weigh on profitability.

  Strengths

  The government and corporate business grew 44% in the first half, the consumer business grew 8%, and AI server momentum and infrastructure investment by leading cloud service providers could support a revenue recovery.

  Weaknesses

  The carrier network business declined 9% in the first half, the second-quarter gross margin fell to 23.2%, and operating cash flow turned negative.

  Comparison

  Nomura uses the Hang Seng Index as its benchmark and maintains a Neutral rating, expecting performance over the next 12 months to be broadly in line with the benchmark.

  Risks

  Lower-than-expected 5G infrastructure spending and an escalation in China-US trade tensions in the technology sector.

Key data

• 1H26 Revenue GrowthUp 6% YoYFirst-half revenue growth disclosed in the report
• 2Q26 RevenueRMB43,037 millionUp 12% YoY and 23% QoQ
• 1H26 ProfitRMB2,753 millionDown 46% YoY
• 2Q26 ProfitRMB1,442 millionDown 45% YoY and up 10% QoQ
• 1H26 Operating Cash FlowNegative RMB126.6 millionDown 110% YoY
• 1H26 Gross Margin25.5%Down 7.0 percentage points YoY
• 2Q26 Gross Margin23.2%Down 7.7 percentage points YoY and 5.1 percentage points QoQ
• Carrier Network Business RevenueDown 9% YoYIn 1H26, mainly affected by persistent pressure in the domestic telecommunications market
• Government and Corporate Business RevenueUp 44% YoYIn 1H26, with demand for servers and storage equipment as the main driver
• Consumer Business RevenueUp 8% YoYIn 1H26, supported by growth in handsets and mobile internet products
• Forecast FY2026 EPSRMB1.88Valuation basis for the target price
• Target Valuation Multiple19x forecast FY2026 P/EUsed to derive the HKD 39 target price
• Current Valuation11.6x forecast FY2026 P/ETrading valuation at the time stated in the report

Impact & implications

The report believes that ZTE's revenue growth engine is increasingly shifting toward AI servers, storage, and other government and corporate businesses, but the rising share of low-margin products is weakening the transmission of revenue growth to profit. If leading Chinese cloud service providers continue to accelerate AI infrastructure investment in the second half, revenue may maintain its recovery; however, as long as domestic carrier capital expenditure remains controlled and the product mix does not improve materially, gross margin pressure may persist.

Risks

• Telecommunications carriers' 5G infrastructure spending may be slower than expected, further affecting demand for the carrier network business.
• An escalation in China-US trade tensions in the technology sector may prevent the target price from being achieved.

What to watch

• Monitor whether domestic telecommunications carriers continue to control capital expenditure and the pace of demand recovery.
• Monitor AI infrastructure investment by leading Chinese cloud service providers and AI server order momentum.
• Monitor whether margins in the government and corporate and consumer businesses improve more than expected.
• Monitor changes in the product mix and the continuing impact of server business expansion on the overall gross margin.