SY - So-Young International: Pay Attention To 2 Key Trends

2023-05-02 14:33:21 ET

Summary

• One key trend for So-Young International Inc. is a divergence in medical aesthetics order volume recovery for upper-tier and lower-tier Chinese cities, which led to companies pulling back on advertising & promotions.
• The other key trend is that more Chinese are traveling abroad with the relaxation of pandemic restrictions, and this might hurt demand for domestic medical aesthetics services in Mainland China.
• A Hold rating for So-Young International Inc. is fair, considering the impact of these two key trends relating to economic recovery and outbound travel, and the stock's current valuations.

Elevator Pitch

My investment rating for So-Young International Inc. (SY) stock remains as a Hold.

I touched on SY's growth prospects for the current year and the latest updates relating to So-Young's shareholder capital return and delisting risk with my earlier February 14, 2023, write-up for the company.

In this latest update for So-Young International, I highlight the potential negative impact of two key trends associated with China on SY's business outlook for the short to intermediate term. So-Young International's revenue expansion might slow in the future, taking into account the varying pace of economic growth in different parts of China and the expected increase in outbound travelers from the country. But the expectations of revenue growth deceleration for SY are already factored into its valuations, so a Hold rating for So-Young International is appropriate.

The Pace Of Economic Recovery Varies For Upper-Tier And Lower-Tier Chinese Cities

I am of the view that there are two key trends relating to China that are expected to have a significant influence on So-Young's future financial performance. I will touch on the first trend in this section, and discuss the second trend in the next section.

Nikkei Asia recently published a news commentary about China on May 1, 2023, titled "Chinese Stocks Falter As Far-Flung Regions Struggle To Recover." In this news article, Guizhou was cited as an example of a Chinese province whose "economic woes have grown so dire recently that it has sought help" to deal with its "mountain of bad real estate loans."

So-Young International's management has observed the same trend of a sharp divergence in the performances of upper-tier (Tier 1 and Tier 2) and lower-tier cities (Tier 3 and Tier 4) in Mainland China. At the company's FY 2022 earnings briefing in late-March, SY noted that the volume of medical aesthetics orders placed by consumers in China's upper-tier cities have already returned to end-2021 levels (prior to the sharp rise in COVID-19 cases last year) by Q4 2022. But the actual medical aesthetics order volume for the lower-tier Chinese cities in late 2022 was still below the levels witnessed towards the end of 2021, as indicated by SY's management.

Considering that the pace of economic recovery varies significantly across different provinces and cities in Mainland China, it is natural that Chinese companies offering medical aesthetics products and services won't be aggressive in ramping up spending on advertising and promotions or A&P. So-Young International revealed at the company's FY 2022 results call that it had observed that "the marketing spend from (medical aesthetics) institutions" are "lagging behind the recovery on the user side."

In my September 12, 2022, initiation article for SY, I highlighted that So-Young International earns more than three-quarters of its revenue from "fees collected from service providers in exchange for sharing information about their medical aesthetics services (i.e. advertising)" on the company's platform. This implies that a moderation in A&P spending for medical aesthetics businesses in China will translate into a slower rate of top line expansion for So-Young International.

According to the sell-side analysts' consensus financial forecasts taken from S&P Capital IQ , the consensus forward FY 2023-2025 top line CAGR estimate for So-Young International is +22.1%. In contrast, SY's actual historical top line CAGR for the period between FY 2018 and FY 2022 was a much higher +37.1%. Apart from the fact that some lower-tier Chinese cities are performing below expectations in terms of economic growth and consumer demand, the increase in the number of Chinese traveling overseas is also another negative trend for So-Young International as detailed in the subsequent section.

Domestic Medical Aesthetics Industry Might Be Negatively Affected By Chinese Outbound Tourism Recovery

There is a misperception that most or all of the businesses operating in China will benefit significantly from the reopening of the country as it pivots away from its COVID-zero policy. In the case of So-Young International, a greater than expected number of Chinese traveling overseas for medical aesthetics services might result in lower-than-expected revenue for SY.

There are signs of a substantial increase in Chinese outbound travel in the months ahead. An April 13, 2023 news article published by Chinese state media The Global Times cited data from Chinese travel agency Trip.com which indicated that "overseas bookings" for China's Labor Day holiday had gone up "by 18-fold from a year ago." Separately, a travel industry publication, The Moodie Davitt Report, also came out with an article on April 25, 2023 highlighting a "significant increase in China outbound seat capacity" for the second quarter of this year.

In its fiscal 2022 20-K filing , So-Young International noted that Mainland China accounts for almost all of its sales. Therefore, it is noteworthy that So-Young International concluded the company's FY 2022 results briefing with the comment that "users will rush to developed overseas markets for medical aesthetics consumption" in tandem with "the rebound in outbound travel." In other words, the rise of medical tourism is negative for the Chinese domestic medical aesthetics industry and So-Young International as well.

SY's Valuation De-Rating Is Consistent With Expectations Of Revenue Growth Deceleration

So-Young International's consensus forward next twelve months' price-to-sales valuation multiple has already derated from its all-time peak of 8.8 times recorded in July 2019 to 1.2 times at the end of the May 1, 2023, trading day as per S&P Capital IQ data.

In the preceding sections of this article, I have mentioned about the market's expectations relating to a slower pace of top line expansion for SY and downside risks associated with So-Young International's future revenue as a result of these two key trends.

As such, it is fair to say that the market is reasonably efficient, and has priced in headwinds for So-Young International Inc. into its valuations to a large extent.

Concluding Thoughts

So-Young International Inc. is valued by the market at a forward price-to-revenue ratio of just 1.2 times, but the company's shares are cheap for valid reasons. An assessment of key trends relating to economic recovery in different Chinese cities and the return of Chinese outbound tourism leads me to the conclusion that So-Young International Inc.'s growth prospects aren't as good as what they were in the past. In conclusion, I deem SY's shares to be worthy of a Hold rating.

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