CHGG - You Ask Chegg Answers: Potential Top AI Investment

2023-09-08 13:02:24 ET

Summary

• Chegg's stock has trended downward despite recent positive news and reaching new highs earlier in the year.
• The company's valuation suggests a potential upside of 40% based on comparisons to peers and Wall Street analysts.
• Chegg's deep value, earnings consistency, and industry-leading position in the education space make it an enticing investment if they can leverage AI, but there are risks to consider.

Smarter Answers = Better Product + Improved Returns

Chegg ( CHGG ) has struggled over the last year of trading, moving down around 52% over the same period, despite reaching new 52-week highs around $30 about this time last year. Chegg specializes in textbooks and online materials for students, primarily in high school and college. Their tools (Figure 1) have become a vital part of learning communities, and this has allowed the company to grow at a very high clip over recent years. In more recent news, the company has begun to look into incorporating AI into their platform . This led to an around 20% gain over the last couple of months on the release of this news. The company has moved into Beta testing utilizing ChatGPT 4 capabilities and allows users to " join the waitlist " now. Nonetheless, the stock continues to trend downward as high growth, premium value names as a whole have fought headwinds in August/September.

Figure 1. Chegg offers a variety of tools to help out students in the classroom

At current prices, Chegg's valuation could offer a potential upside of as much as 40% from current prices based upon comparisons to peers as well as Wall Street Analysts and as little as 20% downside if support holds up during any further macroeconomic headwinds. This presents an enticing 2:1 reward: risk investment opportunity going forward for a stock in the consumer technology industry. We believe these estimates may even be conservative if their AI platform takes off and their data is likely very valuable to bigger AI threats like ChatGPT & Google's Bard, making them a future takeover candidate.

Current Valuation

Chegg trades at a Price to Earnings ratio of just 9x forward earnings. This is much lower than peers, indicating the stock is trading at as much as a 35% discount to competitors, likely because growth has for the most part stagnated since the COVID pandemic. Furthermore, if the stock can again return to trading more as a high-growth tech name with moves in AI similar to peers such as Coursera ( COUR ) and C3.ai ( AI ), Chegg could then be valued much at much higher ratios as it was over the last 3 or so years of public trading. AI has been frowned upon in the educational space in the past, but acceptance has led to growth. The AI educational market is now expected to burst on the scene with a projected 34%+ CAGR over the next decade, which would signal a $30+ Billion TAM. This is good growth news for a struggling Chegg who anticipates the product to be available within the " next two semesters " which would come out to sometime between January and May 2024.

Figure 2. Value vs. Growth of Educational Stocks

This potential return to growth will be key in Chegg's path to success and should be monitored closely. Looking more towards growth metrics, we see that Chegg has done well growing EPS at around 25% annually over the last three years, hinting that the company has done well at cutting costs during this downturn. Furthermore, repurchases of stock will only leverage this number further.

Wall Street Analysts are behind Chegg as well ( Figure 3 ) with an average analyst rating of $13.75 signaling as much as 35%+ upside from current prices. We believe this is reasonable, but could be conservative long term if AI lights a fire under Chegg, propelling their stock higher.

Figure 3. Chegg has a number of buy and hold ratings placed on the stock

This combination of potential turnaround momentum powered by AI, and newfound value, is a decent case for investing in Chegg's stock going forward for the medium to long term.

Risks

Chegg currently has a debt of approximately $788 million. This is around 76% of their total equity and therefore should be monitored going forward as always. Promisingly enough, though, they have been paying this debt down and this number is nearly half of what it was just over a year ago. Continuing to pay this down as profits increase will aid in improving aspects such as the enterprise value of the stock, which trades at a premium to peers.

Based on historical data and when looking at the charts of Chegg's stock, it becomes apparent that there is a fairly strong line of support around the $8.6 mark, but could potentially pull back if new macroeconomic lows are tested. This would indicate as much as 20% downside risk going forward, barring any further macroeconomic headwinds caused by rapidly rising rates and inflation.

Other risks include the unknowns of AI in the educational space. Many schools have gone as far as to ban the use of AI in their institutions, and this could spell trouble for Chegg if they do not find ways to market their new tool without overstepping the bounds created by schools.

Investment Summary

AI from Chegg could be a powerful educational tool with their expansive collection of textbooks, homework, and answers. AI could be introduced for all users as soon as early 2024. This, to us, along with nearly a billion a year in robust revenue, high profit margins , and a discounted valuation, makes Chegg a fairly safe high-upside investment in a stock poised for resurgence. Most AI investments in the current market are overpriced, trading at a substantial premium, but Chegg offers a high AI upside at a discounted value.

With a potential upside of as much as 40% in an approximately 1-2 year time frame due to enhanced potential for ongoing momentum and reliable earnings consistency , Chegg looks to be a hold, if not a buy, going forward. Long term upside could be even more substantial if the educational AI market grows at the rate expected. In our opinion, there is still around 20% downside risk when looking at past levels of support, and this should be taken into account when weighing risk-reward strategies.

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