Zhongtai: AI focuses on core strengths and is also expected to be a "latecomer first" reiterating a "buy" rating for Tencent (00700).

Zhongtai released a research report stating that TENCENT (00700) released its first quarter report for 2026. In 1Q26, the company achieved total revenue of 196.5 billion yuan, a year-on-year increase of 9% and a quarter-on-quarter increase of 1%; Non-IFRS operating profit was 75.6 billion yuan, a year-on-year increase of 9% and a quarter-on-quarter increase of 9%; Non-IFRS net profit was 67.9 billion yuan, a year-on-year increase of 11% and a quarter-on-quarter increase of 5%. Considering the company's continued increase in investment in the AI field, it is expected that the company's revenue for 2026-2028 will be 835.4/923.8/1021 billion yuan, with adjusted net profits of 270.7/297.5/326.2 billion yuan (previously 280.8/312.4/346.8 billion yuan), maintaining a "buy" rating. In terms of AI development, Tencent is striving to reach top-level large models in the Chinese field and create localized AI products with unique features. In terms of models, although the Hanyuan 3.0 model is relatively small in scale, its core value lies in verifying the feasibility of the entire research and development system, computing power infrastructure, data architecture, and training mode, laying a solid foundation for subsequent large-scale research and development. In terms of applications, optimization and upgrades are made on the basis of open-source intelligent programs, self-developed professional intelligent office products are created, and comprehensive strength ranks at the forefront of the industry. Key points from Zhongtai's report: Event: Company released its first quarter report for 2026. In 1Q26, the company achieved total revenue of 196.5 billion yuan, a year-on-year increase of 9% and a quarter-on-quarter increase of 1%; Non-IFRS operating profit was 75.6 billion yuan, a year-on-year increase of 9% and a quarter-on-quarter increase of 9%; Non-IFRS net profit was 67.9 billion yuan, a year-on-year increase of 11% and a quarter-on-quarter increase of 5%. The core business is stable and steady, with AI acting as a business development amplifier, providing multiple dimensions for revenue growth. (1) Value-added services (VAS): Revenue recognition is influenced by the late Chinese New Year, with deferred revenue building up for subsequent quarters. In 1Q26, value-added service revenue increased by 4% to 96.1 billion yuan: including domestic games at 45.4 billion yuan, a 6% increase; international games at 18.8 billion yuan, a 13% increase; and social networks at 31.9 billion yuan, a 2% decrease. Due to the late Chinese New Year holiday, revenue from domestic games and in-game purchases in the domestic market were deferred. In the first quarter, revenue from domestic game flow increased by over 10%, with several evergreen games ("King", "Peace", "Delta") setting new revenue records this quarter, and the new game "Lock Kingdom: World" also performing well. (2) Advertising: AI-powered content distribution and targeted advertising lead to strong revenue growth. In 1Q26, advertising revenue increased by 20% to 38.2 billion yuan. Tencent Marketing AIM and other intelligent delivery products accounted for about 30% of the advertising services for advertisers, and were widely used among advertisers in mini-games, short films, and WeChat mini stores; the video recommendation model parameters were expanded and optimized, leading to a more than 20% increase in total user usage time. (3) Financial and business services (FBS): AI stimulates demand both domestically and overseas, with cloud services driving high revenue growth for enterprise services. In 1Q26, revenue from financial and business services increased by 9% to 59.9 billion yuan. Revenue from enterprise services increased by 20%, benefiting from the rise in demand driven by AI both domestically and overseas, a more favorable pricing environment, and the growth in cloud services revenue; transaction volume for WeChat mini stores maintained rapid year-on-year growth, benefiting from dual incentives for brand merchants and experienced buyers. The impact of AI on the profit and loss statement structure is beginning to show, with models and applications refreshing the AI development system. (1) AI investment: On one hand, the lower initial gross profit margin and higher operating profit margin partly reflect the realization of the AI cost reduction and efficiency enhancement logic. In 1Q26, the overall gross profit margin increased by 1 percentage point to 57%, while the fastest-growing advertising business gross profit margin decreased by 1 percentage point to 55%, and the adjusted EBITDA ratio increased by 1 percentage point to 46%. On the other hand, capital expenditure continues to increase, reflecting the company's more proactive investment in AI. In 1Q26, capital expenditure increased by 16% to 31.9 billion yuan, with capital expenditure payments reaching 37 billion yuan, primarily used to support AI-related investments. (2) AI development: Full efforts are being made to reach top-level large models in the Chinese field and create localized AI products with unique features. In terms of models, although the Hanyuan 3.0 model is relatively small in scale, its core value lies in verifying the feasibility of the entire research and development system, computing power infrastructure, data architecture, and training mode, laying a solid foundation for subsequent large-scale research and development. Hanyuan 3.0 has three core advantages: balanced performance, comprehensive real-world application needs, and outstanding cost-effectiveness. Currently, over 130 internal products in the company have adopted and used Hanyuan 3.0, and the model has consistently ranked first in overseas professional rankings. In terms of applications, optimization and upgrades are made on the basis of open-source intelligent programs, self-developed professional intelligent office products, and comprehensive strength ranking at the forefront of the industry. In 1Q26, Tencent Cloud's Efficiency AI Intelligent Body Solution achieved rapid growth and healthy retention rates. By daily active users (DAU), WorkBuddy has become China's most popular efficiency AI intelligent body service. Investment recommendation: The core business barriers are still present, with commercialization still having potential; AI deployment around core strengths is expected to lead the way, and the "buy" rating is reiterated. Considering the company's continued increase in investment in the AI field, it is expected that the company's revenue for 2026-2028 will be 835.4/923.8/1021 billion yuan, with adjusted net profits of 270.7/297.5/326.2 billion yuan (previously 280.8/312.4/346.8 billion yuan), maintaining a "buy" rating. Risk warning: Risks include weak macroeconomic conditions, increased industry competition, policy risks, AI ethical and responsibility risks, and the risk that public data used in the research report may be outdated or not updated in a timely manner.