KUASF - Kuaishou: Focus On Business Outlook And Shareholder Return

2024-01-12 07:59:42 ET

Summary

• There is a high probability of Kuaishou completing its HK$4 billion share repurchase plan by mid-2024, but its shareholder return yield is unattractive in the absence of dividend distributions.
• Kuaishou's net margins are expected to improve going forward, but the company's top line growth outlook is unfavorable.
• I leave my existing Hold rating for Kuaishou unchanged after evaluating the company's capital return and business prospects.

Elevator Pitch

Kuaishou Technology ( KUASF ) [1024:HK] shares are rated as a Hold.

My prior article written on October 26, 2023 was focused on "policy risks" and potential "selling pressure from key shareholders' potential stake disposals or reduction" for Kuaishou. I analyze Kuaishou's return of shareholder capital and its financial prospects in the current update.

It is encouraging to know that Kuaishou is keen on completing its existing HK$4 billion share buyback program by mid-2024, but the stock's buyback yield isn't attractive, and the company has yet to initiate dividend payments. Separately, the market sees Kuaishou's profit margins expanding in the next few years, but this will be offset by slower top line growth. To sum things up, it is justified for Kuaishou to be rated as a Hold.

Kuaishou's shares can be bought or sold on the Hong Kong Stock Exchange and the Over-The-Counter market. The trading liquidity of the company's OTC shares is low, but its Hong Kong shares boasted an average daily trading value of $100 million (source: S&P Capital IQ ) for the past 10 trading days. Investors can deal in Kuaishou's reasonably liquid shares listed in Hong Kong with US brokerages such as Interactive Brokers.

Spotlight On Buyback Plan And Potential Dividend Initiation

Kuaishou has a HK$4 billion share buyback plan that is effective for the time period between May 22, 2023 and the date of the company's 2024 Annual General Meeting (typically held in mid-June). The company has spent approximately HK$1.55 billion repurchasing its own shares between May 22 last year and January 9 this year.

The key issue with share repurchase programs is that there is a risk that companies don't complete the majority of their planned share buybacks. This is likely to be less of a concern with Kuaishou, as the company has sent a clear signal that it intends to complete its HK$4 billion share repurchase plan before the middle of next year.

Last month, Kuaishou announced that it signed "a share repurchase contract with an independent broker, Morgan Stanley ( MS ) & Co. International Plc" to buy back its Hong Kong-listed shares "for up to HK$2.5 billion" for the December 19, 2023-May 24, 2024 time frame. In other words, it is highly probable that Kuaishou will complete its HK$4 billion share buyback program between May 2023 and May 2024.

Assuming that Kuaishou buys back HK$4 billion worth of its shares within a year as planned, this will translate into a share buyback yield of 1.9% based on the company's market capitalization of HK$207 billion as of January 9, 2024.

The stock price of Kuaishou's Hong Kong-listed shares rose by +7% to HK$53.50 on May 22, 2023, the day on the HK$4 billion share repurchase plan disclosure. But Kuaishou's shares subsequently declined by -11% in the next seven months to close at HK$47.55 at the end of the January 9, 2024 trading day.

In my view, the market has a positive opinion of Kuaishou's move to return capital to the company's shareholders, but investors are likely to expect a higher shareholder return (buybacks and dividend) yield. Kuaishou's buyback yield would have been higher than the current 1.9% (which is decent but unappealing), if the company had paid out dividends on top of buying back its own shares.

At the company's most recent Q3 2023 earnings briefing , Kuaishou stressed that any new "dividend plan" will "depend on various factors." But the company also indicated at its third quarter results call that it will "update" investors if "there are any new developments" relating to a potential initiation of dividends. In a nutshell, a dividend distribution for the first time since Kuaishou's public listing since February 2021 might be the major catalyst that the market is waiting for.

Mixed Outlook Implying Revenue Growth Moderation And Profitability Improvement

The analysts take the view that Kuaishou's top line growth in RMB terms is expected to moderate in the coming years, even though the company's profit margins are projected to expand in the future.

Specifically, Kuaishou's revenue growth is estimated to slow from +21% (forecast) for FY 2023 to +15% and +13% in FY 2024 and FY 2025, respectively. On the other hand, the sell side forecasts that Kuaishou's normalized net income margin will increase from 7.7% in FY 2023 to 11.7% and 15.4% for FY 2024 and FY 2025, respectively.

In terms of the top line outlook, Kuaishou made reference to the "continued optimization of the live streaming ecosystem" at its Q3 2023 results call. It seems that China's live streaming industry is still the subject of regulatory scrutiny, which might affect the company's revenue growth prospects.

A November 29, 2023 South China Morning Post news article cited "an opinion piece" from Chinese state media The People's Daily that "advocates for more regulations of the live-streaming e-commerce industry" in China. Separately, Baidu's ( BIDU ) planned acquisition of the Mainland Chinese live streaming division of JOYY (Y) was recently aborted, and this deal didn't secure the necessary "regulatory approvals" as reported by Seeking Alpha News on January 2, 2024.

With regards to future profit margins, Kuaishou's expenses relating to content creation might potentially decrease over time with the rise of generative AI. Chinese technology news portal PingWest highlighted in a June 2023 commentary that Kuaishou was working on "the creation of product copy, images, ad scripts, video effects, and other content using AI."

Macquarie Securities issued a research report (not publicly available) on the Chinese internet sector titled "How Can We Have Prosperity Without Growth?" on December 7, 2023. As indicated in this late-2023 report, Macquarie estimates that approximately 39% of the content-related costs for Chinese internet companies might be "replaced or optimized by AIGC (AI-Generated Content)" by 2030. This provides an indication of the potential expense savings that Kuaishou could enjoy in the coming years by leveraging on generative AI.

In summary, Kuaishou's prospects are mixed, considering both its revenue and profitability outlook.

Final Thoughts

There are both positives and negatives associated with Kuaishou's shareholder return and business outlook. Also, Kuaishou seems to be neither overvalued nor undervalued, which points to a Hold investment rating. Based on the valuation formula that a 10% EBIT margin supports an Enterprise Value-to-Sales or EV/S multiple of 1.0 times, Kuaishou's current consensus next twelve months' EV/S ratio of 1.26 times (source: S&P Capital IQ ) is pretty close to fair valuation considering the market's consensus FY 2025 EBIT margin estimate of 13.3% (which implies a fair EV/S metric of 1.33 times).

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