Momo ADR – attractive valuations despite strong growth

Summary

  • China’s leading mobile-based social and entertainment platforms.
  • Strong growth in paid value-added services drawing in revenue
  • Attractive valuations despite the strong growth

 

Growth company at attractive valuations

Momo is a leading mobile-based social and entertainment platform in China. It allows users to expand their social networks based on location and interests. The platform allows users to watch videos, play games and interact with each other via audio and video. Some of the features include Nearby Users, Groups, Message Board, Topics, and Nearby Events.

Launched in 2011, the company had 99.1 m users (paid and unpaid) as at Dec 2017, a growth of over 20% as compared to the previous year. As a result of paid value-added services, revenue has grown by about 140% to US$1,318.3 m in 2017. Revenue gain came from both an increase in the number of paid users as well as average revenue per user.

Paid memberships cost about US$2 per month. These paid memberships entitle the users to advanced search options, higher limits on the number of users they can put in a group, ability to see who viewed their profiles, etc. Another source of revenue is gaming. Third parties develop the games on Momo’s platform and revenue from in-game purchases are shared between Momo and the developers.  Another source of revenue is advertisements. Merchants can create profile pages of their businesses and these can be found by Momo users. Momo plans to take this even further by referring users to e-commerce stores such as Alibaba and getting a cut of the revenue.

Other sources of income include video streaming, as users pay to watch popular programs streamed to their mobiles. Users can also purchase virtual gifts and send to one another, yet another revenue source for Momo.

First quarter 2018 results were impressive. Revenues gained 64% yoy to $435.1 m while net income increased by about 60% to $129.9 m. There was an increase of 15.7% in the number of paid users to 8.1 m users at the end of first quarter 2018.

Besides growing organically, the company is also relying on acquisitions for growth. It recently acquired social dating platform Tantan, which has seen growth in both user growth and monetization since the beginning of this year.

Net profit margins are healthy at above 20%. Return on Equity is above 30%. Notwithstanding the strong growth, the company is trading at attractive valuations of 22.5x 2018’s earnings and 17.8x 2019’s earnings.

 

Stock Valuation

We first look at valuation from the standpoint of popular indicators – Price to Earnings, Price to Sales, Price to Cash Flow, Price to Book and Dividend Yield.

Momo PE Ratio

The Price Earnings (PE) Ratio is the most frequently used valuation indicator for a stock. However, there are times when this ratio cannot be used e.g. when the company reports a loss or profit is so minimal that it results in an abnormally high PE Ratio. Or Net Profit After Tax may be volatile and it is better to use Earnings Before Interest and Tax (EBIT) to value the company.

At the price of USD48.17 as at 27 Jun 2018, Momo Inc is trading at a PE Ratio of 26.2 times last 12 months earnings.  This is a 8.6% premium to its historical average Price to Earnings Ratio of 24.1 times. (Price based on the historical average PE of the company is indicated by the red line.)

Momo Price to Sales

The Price to Sales Ratio is another commonly used valuation indicator for a stock. It overcomes some of the limitations of the Price Earnings Ratio in that it can be used even when the company is not making a profit or only making minimal profits. However, it should not be used by itself because a company may be achieving sales but not profits.

At the price of USD48.17 as at 27 Jun 2018, Momo Inc is trading at a Price to Sales Ratio of 5.8 times last 12 months sales.  This is at par to its historical average Price to Sales Ratio of 8.7 times.

Momo Price to Cash Flow

Price to Cash Flow is an alternative method to value shares. This is because accounting profits can be subject to manipulation. Therefore, some investors prefer to value a company based on cash flows generated by the operating activities of the company. It also acts as a reality check to valuation measures such as Price to Earnings and Price to Sales. If a company generates high profits and sales but not operating cash flows, it could be heading for trouble because it is cash that pays the operating expenses. However, the Price to Cash Flow ratio of most firms are volatile and should not be used in isolation to determine the valuation of the stock.

At the price of USD48.17 as at 27 Jun 2018, Momo Inc is trading at a Price to Cash Flow Ratio of 17.7 times last 12 months cash flow.  This is a 1.0% premium to its historical average Price to Cash Flow Ratio of 17.5 times.

Momo Price to Book

Price to Earnings, Price to Sales and Price to Cash Flow ratios all value a company based on what it is generating (i.e. profits, sales or cash flow). Price to Book ratio is different in that it values a company based on what it owns (i.e. its net assets). This is usually a suitable valuation indicator for a financial institution, which frequently revalues its assets and liabilities, or a company with huge asset base e.g. utilities company.

At the price of USD48.17 as at 27 Jun 2018, Momo Inc is trading at a Price to Book Ratio of 8.5 times current book value.  This is a 68% premium to its historical average Price to Book Ratio of 5.0 times.

The company does not have sufficient dividend history to determine valuation based on dividend yield.

Everybody has his favourite valuation indicator. Although most people would use Price to Earnings Ratio to value stocks, others believe that profits are open to manipulation and Price to Cash Flow is a better measure. Yet others rely on Price to Sales Ratio to value companies as this measure can be used even at times when the company is not profitable. Another way to value companies would be to value its assets and typically the Price to Book Ratio is used for that. Income investors who invest mainly for dividend income like to use the Dividend Yield to find companies that are undervalued.

We believe that each of these methods has its pros and cons. Therefore, we reckon that the best way is to use all five indicators and let empirical data find us the best possible combination of these five indicators that explains the stock’s price.

To find out more about our valuation methodology, click here.

Using a combination approach, we found a Composite Valuation Indicator that explains the stock price better than any of the standalone indicators above. And it gives you one signal to decide whether to buy, hold or sell the stock. The problem with using different standalone indicators is that they may give you different signals. Some may tell you it is overvalued while some tell you it is undervalued. This is no help to an investor who must make a definite decision whether to buy, hold or sell the stock.

Momo Composite Valuation Indicator

Based on the Composite Valuation Indicator, the stock has a Target Price of USD62.65 within a 12-month period. Our Target Price represents upside of 30.1% based on stock price of USD48.17 as at 27 Jun 2018. The target price takes into account the appropriate valuation of the company and its future fundamentals i.e. profit, sales, cash flow, book value, dividends, etc.

We recommend that investors start to take profit after upside of 20% to 25%.

Other Considerations                                                                                                  

Of course, in deciding whether or not a stock is attractive, it is more than determining its valuation and future fundamentals. We need to consider other aspects of the stock such as growth, earnings quality, financial condition, operational excellence, cash flow, technicals, etc.

It is difficult to find a stock that is attractive valued and still pass every single criterion of the investor with flying colors. At times, we need to make certain trade-offs. For a full quantitative analysis, you could refer to this report.

 

Conclusion                                                                                                

Momo ADR is a growth stock that is trading at attractive valuations. It has a leading position in China in the mobile-based social and entertainment space. It has shown ability to monetize its value-added services and grow its paid user numbers. The company also enjoys healthy profit margins of over 20% and ROE of over 30%.

 

Source of Data: Valuation charts are from the ProThinker Stock Report. Company description, historical financial statements data and price data are from gurufocus.com. Estimates are from gurufocus and/or 4-traders.com – Thomson Reuters.

Disclaimer: This report is for information purposes only and should not be considered a solicitation to buy or sell any security. Neither ProThinker nor any other party guarantees its accuracy or makes warranties regarding results from its usage. Redistribution is prohibited without the express written consent of ProThinker. Copyright(c) 2018. All rights reserved.