ZTE stock downgraded to Underperform by Jefferies on AI optimism concerns

Jefferies has downgraded ZTE Corp. (HK:763) to Underperform from Hold, despite raising its price target to HK$27.27 and the stock's significant 52% rally over the past three months, citing "excessive market optimism" around AI-related growth. The downgrade stems from ZTE's Q2 2025 miss on core operating and net profit, despite a revenue beat. Jefferies highlighted that while server revenue grew 200%, its low 4-5% gross margins are problematic, especially alongside a 6% decline in high-margin telecommunications revenue, leading to lower overall margins and forecast cuts below consensus, indicating the stock is overvalued.

Analysis

Jefferies has downgraded ZTE Corp. to Underperform from Hold, signaling that the stock's recent rally is disconnected from its underlying financial performance. This action comes despite a significant 52% share price increase over the last three months, which Jefferies attributes to "excessive market optimism" surrounding the company's AI and ASIC growth potential. The core of the bearish thesis stems from ZTE's second-quarter 2025 earnings, where the company missed core operating profit and net profit estimates despite a revenue beat. This discrepancy is explained by a significant shift in revenue mix: while server revenue grew an impressive 200%, it operates at a very low gross margin of 4-5%. Concurrently, the highly profitable telecommunications segment, which boasts a 53% gross margin, experienced a 6% revenue decline. This margin dilution, combined with current valuation multiples of 29.5x P/E and 21.4x EV/EBITDA, supports the view that the stock is overvalued, leading Jefferies to cut its forecasts below consensus.

Key Decisions for Investors

• Given the stock's 108% rally over the past year and the analyst's view of "excessive market optimism," investors should consider trimming positions to lock in gains, as the valuation appears stretched relative to underlying profitability.
• Investors must look beyond headline revenue growth and critically monitor the company's gross margin trends, specifically the mix between low-margin server sales and declining high-margin telecommunications revenue.
• The downgrade could act as a catalyst for a price correction; therefore, it is prudent to be cautious and watch for further evidence that the market is re-evaluating the company based on profitability rather than AI-driven sentiment.