TUYA - Tuya: Capital Allocation Approach Draws Attention

2023-11-29 11:25:17 ET

Summary

• TUYA's recent Q3 2023 results bring the company's capital allocation strategy into the spotlight.
• Tuya's third quarter non-GAAP adjusted earnings beat expectations, but the company would have been loss-making without the interest income derived from its cash.
• The stock's valuations are undemanding, so it might have been better for TUYA to allocate capital to share buybacks rather than retain a substantial amount of cash to earn interest.
• I have decided to maintain my Hold rating for Tuya stock, considering both positives and negatives associated with its current capital allocation approach.

Elevator Pitch

My rating for Tuya Inc. ( TUYA ) [2391:HK] is a Hold. Earlier, I touched on TUYA's performance for the second quarter of this year and assessed the company's short term financial outlook in my September 15, 2023 article .

With the current write-up, I review Tuya's latest quarterly financial results and its capital allocation framework. The company's headline numbers for Q3 2023 surpassed expectations, and its bottom line was boosted by a significant amount of interest income in the recent quarter. I am impressed with how TUYA has generated meaningful interest income with good cash management, but I think that Tuya has excess cash on its books and it should have allocated capital to share repurchases. After analyzing TUYA's third quarter financial metrics and how the company has allocated capital, my view is that a Hold rating for the stock is justified.

TUYA's Reported Financial Numbers Were Better Than Expected

TUYA published a press release disclosing its Q3 2023 financial performance on Tuesday, November 28 after trading hours. The company's key financial metrics for the most recent quarter exceeded the market's expectations.

Top line for Tuya grew by +35.7% YoY to $61.1 million in Q3 2023, which was +6.8% higher than the analysts' consensus top line projection of $57.2 million . The +48.1% YoY surge in IoT (Internet of Things) PaaS (Platform-as-a-Service) revenue and the +32.1% YoY increase in smart device distribution revenue were more than sufficient to offset a -5.0% YoY decline in SaaS (Software-as-a-Service) & others revenue in the latest quarter.

In its third quarter earnings release, Tuya attributed the robust top line expansion for Q3 to "the relief of downstream inventory backlog and a global economic improvement."

The company's normalized operating loss shrunk from -$31.4 million in Q2 2023 and -$23.7 million in Q3 2022 to -$3.5 million for the recent quarter. In contrast, the sell side had anticipated that TUYA's Q3 2023 non-GAAP adjusted operating loss will be wider at -$26.7 million (source: S&P Capital IQ ).

Tuya's narrower-than-expected Q3 2023 loss from operations was due to a more favorable sales mix and excellent cost control. The optimization of TUYA's sales mix was evidenced by the fact that the company's gross profit margin expanded by +310 basis points to 46.7% in Q3 2023, which turned out to be 0.6 percentage points above the consensus estimate of 46.1% as per S&P Capital IQ consensus data. Also, Tuya saw its sales & marketing costs and research & development costs decrease by -33.3% YoY and -22.9% YoY to $9.4 million and $24.9 million, respectively.

I evaluate TUYA's bottom line performance in the subsequent section.

But Tuya Would Have Been Loss Making Without Interest Income Contribution

TUYA's actual Q3 2023 non-GAAP adjusted net income of $10.1 million came in way better than the sell side's consensus normalized earnings forecast of $0.7 million (source: S&P Capital IQ) . As a comparison, Tuya suffered from a -$15.9 million normalized net loss in Q3 2022, and the company reported a relatively lower non-GAAP net profit of $1.5 million for Q2 2023.

However, Tuya's bottom line performance for the latest quarter wasn't as good as what it appears on the surface. Specifically, TUYA's most recent quarter earnings were boosted by a key non-operating item.

The company registered an interest income of $13.1 million for Q3 2023. Excluding interest income, TUYA would have delivered a normalized net loss of -$3.6 million and missed the market's expectations. Tuya highlighted in the company's Q3 2023 results press release that it had "well implemented treasury strategies" relating to its "cash and bank deposits."

It is encouraging to know that Tuya had managed its cash well to take advantage of the rising rate environment. But it is important to recognize that non-operating factors (i.e. interest income) had a positive impact on TUYA's bottom line in Q3 2023.

All Eyes On TUYA's Capital Allocation Strategy

In the preceding section, I mentioned that Tuya achieved a reasonably high interest income amounting to $13.1 million, which was a major driver of the company's third quarter bottom line beat. This brings TUYA's capital allocation strategy into the spotlight.

At its Q3 2023 earnings briefing , a sell-side analyst from Goldman Sachs ( GS ) asked about how TUYA thinks about allocating capital. In response, Tuya noted that it strikes a balance between "striving to preserve cash through safe highly liquid fixed deposits", and looking out for "suitable merger acquisition opportunities" and investing in "fixed assets for long term operations."

As of September 30, 2023, the company had net cash of approximately $961 million on its balance sheet which is pretty close to its market capitalization of slightly over $1 billion. It is good that Tuya is earning a decent amount of interest income from its cash balance. But this does raise the question of whether TUYA will be better off returning excess capital to shareholders, rather than retaining such a huge amount of cash on the company's books.

The company initiated a new one-year $50 million share buyback plan that is effective for the period between June 2023 and June 2024. But Tuya didn't provide any updates on share repurchases when it reported its Q2 2023 and Q3 2023 results in August and November, respectively. As such, it is reasonable to assume that TUYA has yet to execute on any share buybacks since June this year.

The market currently values Tuya at 1.11 times trailing twelve months' price-to-book and 0.51 times consensus forward next twelve months' Enterprise Value-to-Revenue as per S&P Capital IQ data. It is fair to say that TUYA's stock is inexpensive and buying back its own shares will be value accretive. Therefore, I am disappointed with the absence of buybacks for Tuya.

Final Thoughts

My opinion of TUYA's capital allocation strategy is mixed, and this implies that a Hold rating for the stock is fair. On one hand, Tuya has derived significant interest income from the cash pile on its balance sheet. On the other hand, there are other superior choices relating to the allocation of excess capital, such as share buybacks that should be accretive based on TUYA's current valuations.

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