SY - So-Young International: Justifiably Cheap

2023-09-26 15:05:07 ET

Summary

• So-Young International currently trades at a trailing price-to-tangible book multiple of 0.45 times and a forward price-to-revenue ratio of 0.47 times.
• Both SY's consensus top line and operating income forecasts have been lowered meaningfully in the past few months.
• I leave my Hold rating for SY unchanged, as its valuation multiple compression is justified by weaker expectations of the company's future financial results.

Elevator Pitch

I still rate So-Young International Inc. ( SY ) shares as a Hold.

SY's shares have performed badly in recent months, and the stock now trades at below half of both its historical tangible book value and expected sales. But I am unwilling to upgrade the stock to a Buy, as I am unimpressed by So-Young's revenue and profitability outlook. Since SY is justified to be trading at its current valuations, I maintain a Hold rating for the stock.

Share Price Underperformance And Valuation Multiple Compression

In close to five months following my prior article for SY published on May 2, 2023, So-Young International's stock price plunged by -58.3% as per Seeking Alpha price data. The S&P 500 went up by +4.9% in the same time frame.

SY's consensus forward next twelve months' price-to-revenue ratio also more than halved from 1.15 times (source: S&P Capital IQ ) as of May 2 to 0.47 times at the end of the September 22, 2023, trading day. During this same time period, the historical trailing twelve months' price-to-tangible book value multiple for So-Young International de-rated from 1.05 times to 0.45 times.

In the subsequent two sections of the article, I highlight that negative expectations of the company's financial performance have led to poor stock price performance and valuation multiple compression for SY.

Downward Revision In Revenue Forecasts

The sell-side's consensus FY 2023, FY 2024, and FY 2025 top line estimates (in local currency or RMB terms) for SY were revised downwards by -3%, -5%, and -9% (source: S&P Capital IQ ), respectively since the beginning of May this year.

The analysts' current consensus revenue projections point to So-Young International delivering sales growth rates (in RMB terms) of +22%, +18%, and +15% for FY 2023, FY 2024, and FY 2025, respectively. These numbers seem to be fairly realistic, as the medical aesthetics market in Mainland China is projected to expand at a CAGR of +15% for the 2024-2027 time period as per a market research study conducted by Deloitte Consulting and Allergan Aesthetics .

In contrast, SY's revenue expanded by a much better +31% in FY 2021, before its top line contracted by -26% for FY 2022 as the COVID-19 pandemic was at its worst in Mainland China last year.

Separately, the mid-point of So-Young International's latest third quarter revenue guidance at RMB390 million implies that the company expects its sales to decline by -5% QoQ in Q3 2023. In other words, SY's top line guidance appears to be consistent with the lowering of analysts' revenue growth expectations for the company.

With my early May update, I mentioned that "the varying pace of economic growth in different parts of China and the expected increase in outbound travelers from the country" could potentially have a negative impact on SY's top line growth prospects.

Furthermore, some of So-Young International's new growth initiatives might also be affected by headwinds for China's healthcare industry. In an August 16, 2023, Morgan Stanley ( MS ) research report (not publicly available) titled "Roadmap for Navigating the Health System Anti-Graft Wave", it is noted that "many academic conferences, hospital tenders, and sales rep activities are coming to a standstill" due to "the start of a year-long healthcare system antigraft campaign" in China.

It must be emphasized that So-Young International isn't the subject of any related probe. But certain of the company's expansion plans could be indirectly impacted by industry woes. For example, SY revealed at its Q2 2023 results call in late August that the company "recently launched a program in partnership with public hospitals" in relation to "eye procedures." There is the risk of a delay in the roll-out of this program or other similar programs relating to collaborations with hospitals and other healthcare organizations in the country.

Dim View Of Future Operating Profitability

Expectations regarding So-Young International's profitability have been reset.

At the start of May, the market was predicting that SY would be able to generate a positive operating profit of RMB76 million for the current year. But the current consensus financial forecasts for So-Young International as per S&P Capital IQ data suggest that the company is expected to suffer from an operating loss of -RMB5 million this year. Also, the consensus EBIT FY 2024 and FY 2025 estimates (in local currency terms) for the company were slashed by -62% and -50%, respectively, in the last five months.

There are good reasons for the pessimistic view about So-Young International's operating profitability going forward.

SY's actual Q2 2023 operating loss amounting to -RMB20.7 million was much worse than the analysts' consensus EBIT projection of -RMB12.3 million as per data taken from S&P Capital IQ . The company's net loss attributable to shareholders of -RMB2.6 million in the second quarter was wider than the sell-side's consensus bottom line estimate of -RMB0.9 million.

So-Young International's below-expectations EBIT and bottom line in Q2 2023 were mainly attributable to an unfavorable sales mix and investment in new initiatives.

At its Q2 earnings call, SY guided for its gross margin to "remain at an approximately similar level" for the near future, considering that it intends to invest in "So-Young Prime's promotional activities and expand sales of medical products and maintenance services." As a reference, SY's gross profit margin contracted from 66.2% in Q1 2023 to 63.5% for Q2 2023.

The profitability of the company's medical products and maintenance services business is inferior to that of its reservation services and information services businesses. As such, SY's greater focus on its medical products and maintenance services business will translate into weaker profitability.

On the other hand, SY's new growth initiative So-Young Prime, which the company referred to as a "proprietary one-stop nonsurgical medical aesthetic solution" at its Q2 results briefing, will require investments to support its future expansion.

Closing Thoughts

The market has lowered its expectations of So-Young International's future top line growth and operating profitability, which explains why SY's share price has fallen substantially in recent months. I don't see any near-term catalysts which could re-rate the stock's valuations, so I continue to have a Hold rating for So-Young International.

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