SY - So-Young: Focus On Supply Chain Business And Profitability Prospects

2023-12-08 08:38:11 ET

Summary

• SY's upstream supply chain business has the potential to grow further on the back of new collaborations and the proposed IPO of Wuhan Miracle.
• So-Young International's actual normalized operating losses for both Q2 2023 and Q3 2023 turned out to be wider than what the market predicted.
• SY's shares are rated as a Hold based on my evaluation of the company's upstream supply chain business and its profitability outlook.

Elevator Pitch

I have a Hold investment rating for So-Young International Inc. ( SY ) stock. In my previous September 26, 2023 update for So-Young International, I wrote about SY's share price underperformance and valuation de-rating.

With the current write-up, my attention turns to So-Young International's supply chain business and its profitability prospects. SY's upstream supply chain is expected to drive the company's top-line expansion, but I take the view that So-Young International's profitability in the future could turn out to be below expectations. This explains why I have chosen to retain a Hold rating for So-Young International.

Spotlight On Supply Chain Business' New Partnership And Proposed Listing

SY's upstream supply chain business is becoming an increasingly important component of the company's overall operations.

In its Q3 2023 earnings press release , So-Young International described its upstream supply chain business as being engaged in the "sales of medical products and maintenance services." Revenue derived from SY's upstream supply chain business increased by +19.2% YoY to RMB75.2 million for Q3 2023, which accounted for 19.5% or almost a fifth of the company's top line in the latest quarter.

My view is that SY's upstream supply chain business is in a good position to further expand in the future, taking into account its recent collaboration on new product development and the planned listing of Wuhan Miracle.

At the start of this month, So-Young International revealed that it is partnering "Healtech, a fully-integrated contract research organization and contract manufacturing organization" to manufacture and market "a silk fibroin-hyaluronic acid compound solution and an extracellular matrix bio gel injectable filler."

Earlier, SY mentioned at its Q3 2023 results call that it managed to secure "distribution rights of 2 filler products" from a pharmaceutical company in July 2023 to boost its "light medical aesthetics product portfolio." It is reasonable to assume that So-Young International's latest partnership with Healtech will serve a similar purpose of expanding SY's range of products for its upstream supply chain business.

Separately, So-Young International disclosed in the middle of last month that the company's "subsidiary Miracle Laser Systems, Inc. ('Wuhan Miracle') recently has submitted the application documents for its potential initial public offering and listing on the Beijing Stock Exchange." SY first invested in Wuhan Miracle in June 2021 , and Wuhan Miracle currently forms part of So-Young International's upstream supply business as highlighted in SY's third-quarter earnings briefing.

While detailed financial information regarding the proposed IPO of Wuhan Miracle isn't available yet, it is realistic to expect that So-Young International can leverage on the Wuhan Miracle listing to fund the future growth plans of this particular business. SY indicated at its Q3 earnings call that Wuhan Miracle has developed "a new generation of ultrasonic anti-aging equipment called as the micro-focused ultrasound device" that the company is capitalizing on to "build out our direct-to-consumer business."

It is likely that the upstream supply chain business' positive outlook has given SY the confidence to guide for stronger revenue growth in the final quarter of the year. The mid-point of So-Young International's Q4 2023 top-line guidance is RMB390 million, which translates into a +20.6% YoY sales expansion that is superior to SY's Q3 2023 local currency or RMB revenue increase of +19.2% YoY.

In summary, So-Young International's upstream supply chain business has good growth potential, which can be realized with new partnerships and the public listing of Wuhan Miracle.

Profitability Improvement Progress Hasn't Been As Good As Expected

So-Young International's progress relating to its efforts to improve profitability has fallen short of the market's expectations.

SY reversed from a positive non-GAAP operating profit of +RMB0.3 million in the third quarter of 2022 to record a normalized operating loss of -RMB10.8 million for the third quarter of the current year. Prior to the company's actual Q3 2023 financial results release, the market was expecting So-Young to register a much narrower non-GAAP adjusted operating loss of -RMB6.0 million as per S&P Capital IQ's consensus data. It is worthy of note that So-Young International's actual Q2 2023 adjusted operating loss of -RMB20.7 million was also worse than the sell side's consensus forecast of -RMB12.3 million.

A +15.3% YoY growth in sales and marketing costs was the key factor contributing to SY's wider-than-expected normalized operating loss for the most recent quarter.

Looking ahead, the sell-side analysts' consensus full-year fiscal 2024 normalized operating income was reduced significantly by -68% from RMB253 million in mid-August this year to RMB80 million (source: S&P Capital IQ ) as of December 7, 2023.

There are good reasons to be worried that So-Young International's future profitability might disappoint the market. At its Q3 2023 results briefing, SY stressed that it "will continue investing in acquiring high-quality users and institutions" and "carefully manage marketing costs to maintain our margin." Therefore, elevated marketing spend and a meaningful amount of investments could still be a drag on SY's profitability in the foreseeable future.

Final Thoughts

I stick to a Hold rating for SY. On one hand, I am positive on the company's revenue growth outlook, as I have a favorable view of its upstream supply chain business. On the other hand, my opinion is that the pace of So-Young International's profitability improvement could fail to live up to investors' expectations.

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