KC - Kingsoft Cloud: Still Neutral Considering Future Performance And Valuations

Summary

• Kingsoft Cloud has witnessed a meaningful stock price decline and valuation multiple de-rating over fears of share loss in the cloud market and a longer time needed to achieve profitability.
• However, further downside for KC's shares should be limited by the fact that its valuations are already depressed and that there are positive expectations of an improved 2023 financial performance.
• After taking into account how the company could perform in the next few years and the stock's current valuations, I think that KC still deserves a Hold rating.

Elevator Pitch

I have a Hold investment rating for Kingsoft Cloud Holdings Limited's ( KC ) shares. I previously wrote about KC's poor financial guidance for the third quarter of last year with my earlier update for the stock published on October 17, 2022.

In this latest write-up, I evaluate how Kingsoft Cloud's shares have performed since the company's public listing, and I also touch on KC's financial and stock price outlook.

Kingsoft Cloud's shares have fallen quite a lot since its IPO in May 2020, and this seems fair considering the timeline for profitability and risks relating to market share loss. On the flip side, it isn't reasonable to expect another big drop in KC's share price anytime soon, as its shares are pretty cheap on both peers and historical comparisons. As such, I still rate KC as a Hold.

Post-IPO Stock Price Performance And Changes In Valuation Multiple

Kingsoft Cloud's shares were first listed on the Nasdaq in May 2020 with an IPO price of $17 . Based on data sourced from S&P Capital IQ , KC's stock price rose to $21.41 as of June 1, 2020, which translated into a consensus forward next twelve months' Enterprise Value-to-Revenue valuation multiple of 5.9 times. On February 11, 2021, the market valued Kingsoft Cloud at 10.2 times (historical peak) consensus forward next twelve months' Enterprise Value-to-Revenue, as KC's shares closed at $72.06 on that day.

In the two years between February 2021 and February 2023, KC's stock price has dropped substantially, while its valuation multiple suffered from a severe de-rating over the same period. As of February 24, 2023, Kingsoft Cloud's last done stock price was $3.85, which is 77% below its IPO price. This also meant that KC's consensus forward next twelve months' Enterprise Value-to-Revenue valuation multiple had compressed to a mere 0.44 times.

Share Price Decline And Valuation De-rating Are Justified

Kingsoft Cloud's share price performance in recent years is aligned with the intermediate term prospects of the company.

Revenue growth for KC in local currency or RMB terms has already slowed from +66.2% in fiscal 2020 to +37.8% for FY 2021. As per S&P Capital IQ's consensus financial projections, the sell-side expects Kingsoft Cloud's top line to contract by -6.9% to RMB8,439 million for full-year FY 2022. Even though KC might stage a revenue recovery in subsequent years, the analysts' consensus FY 2023-2025 top line CAGR for Kingsoft Cloud is a modest +8.4%.

The key reason for Kingsoft Cloud's lackluster medium-term revenue growth outlook is the potential loss of market share for private cloud players such as KC and its peers such as Alibaba ( BABA ) Cloud and Tencent ( TCEHY ) ( TCTZF ) Cloud.

Baillie Gifford published a research report in November 2022 titled "Why China's Cloud Is Different" which forecasted that "Alibaba and Tencent’s revenue share (of China's cloud market) might fall" between 2022 and 2026. Baillie Gifford's analysts expect Chinese state-owned telecommunications companies to take market share away from private cloud companies like Tencent Cloud and Alibaba Cloud in the future, as the country places a stronger emphasis on data security. Specifically, Chinese state-owned telecommunications companies as a group could potentially have as much as 50% revenue share of China's cloud market in 2026 as per Baillie Gifford's report.

In light of slower top-line growth expectations, Kingsoft Cloud might remain unprofitable and free cash flow negative for many more years, as the company's cash flow and bottom line are hurt by negative operating leverage.

According to the sell-side analysts' consensus estimates, the market sees KC staying loss-making between FY 2023 and FY 2025. Although the analysts think that Kingsoft Cloud could possibly turn profitable in FY 2026, the consensus FY 2026 normalized net profit margin forecast for KC is just 1.3% and the company is projected to still be free cash flow negative in that year. In other words, it could take a very long time for Kingsoft Cloud to achieve positive free cash flow and reasonably decent profitability.

Further Share Price Downside Should Be Limited

On the positive side of things, Kingsoft Cloud's current share price and valuations should have already priced in negatives for the stock, and the company's shares aren't likely to drop significantly again in the very near term.

With respect to valuations, I noted in an earlier section of the current article that Kingsoft Cloud is valued by the market at a consensus forward next twelve months' Enterprise Value-to-Revenue ratio of 0.44 times which is pretty cheap in absolute and historical terms. Furthermore, Kingsoft Cloud is now trading at a wide discount to its closest peers. As per S&P Capital IQ data, the market currently values KC's listed peers, UCloud Technology Co Ltd [688158:CH] and Taiji Computer Corp Ltd [002368:CH], at comparatively higher consensus forward next twelve months' Enterprise Value-to-Revenue multiples of 1.87 times and 2.02 times, respectively.

With regards to analyst sentiment, the sell-side appears to have an increasingly positive view of Kingsoft Cloud's bottom line performance for full-year FY 2023. The current consensus FY 2023 GAAP net loss per share estimate for KC is -RMB4.97 (source: S&P Capital IQ ), as compared to a wider consensus 2023 net loss forecast of -RMB5.53 per share at the end of last year and the company's expected 2022 net loss per share of -RMB9.71.

Expectations of narrower losses for KC in 2023 are reasonable. At the company's prior Q3 2022 earnings briefing in November 23, 2022, Kingsoft Cloud noted that it has become more discerning when it comes to selecting projects or customers with profitability being a key consideration. A more favorable sales mix tilted towards higher-margin clients and projects will allow KC to narrow its losses in 2023.

Closing Thoughts

My view of Kingsoft Cloud's shares is still Neutral. The risk-reward for KC appears to be reasonably fair, based on an evaluation of the company's prospects and valuations.

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