Since I last wrote about China’s car service provider SunCar Technology Group (NASDAQ:SDA) in July the share price fell by 32%. This was not unexpected. At the time, its market multiples indicated that it was richly valued, especially in the context of a slowdown risk in China and its rising expenses, partly on provisions for bad debts.
That a correction was needed was further confirmed when the company’s follow-up share offering to institutional investors was made at a relatively low price in October. Its first half (H1 2023) results are also mixed. Here I take a closer look at both these and other significant developments to assess whether SDA has now corrected enough to make it attractive.
Follow-up offers indicate a lower valuation
At the time I last wrote, the stock price was at USD 8.85. Although it had seen a lot of volatility since the SPAC listing in May of this year, at this price SDA was still trading comfortably at 44.8% above its first close. The price rose further to $11.9 on average from then until the end of October, when the follow-up announcement closed at $8.18.
It is not surprising then that the price fell after this announcement. However, at last close, the stock has also fallen significantly from these levels, closing at $6. Of course, this suggests that it has now overcorrected. The question now is, is there anything in the fundamentals and market multiples that indicate it may soon rebound?
Strong revenue increase
The company’s sales results are really encouraging. With 28% year-on-year (YoY) revenue growth for 1H 2023, it is now closer to historical growth rates (see chart below) after COVID-19-related disruptions resulted in slower growth of 13% for the full year 2022 .SunCar Technology has experienced an increase in growth even from the 1st half of 2022, when it was 10%.
The company’s largest revenue-generating segment, automotive after-sales service, with a revenue share of 62% in H1 2023, saw growth of 10% (2022: 6%). But the real increase continued to come from insurance brokerage services and technology services revenues, which grew by 63% and 132% respectively. As smaller segments, it is of course easier for them to show faster growth, but even then it is clear that they have played their part in pulling overall growth up significantly.
Weaker profit performance on rapidly increasing costs
However, the profit did not see quite the same robustness as the sales. Gross margin came in at 13.8%, even with growth of 11.8%. Not only is the margin now lower than the 17.8% seen for full year 2022, but also down from the 15.75% level seen in 1H 2022. This is because cost of revenue showed a sharp increase of 30.8 % (2022: 9.5%, 1st half of 2022). 2022: 10.6%) in the first half of 2023.
Operating costs had already increased by 23% in 2022 due to higher R&D expenses, in addition to provisions for bad debts. They also continued to show accelerated growth in H1 2023 at 33%. As it trickled down from the gross level, this resulted in an 81% year-over-year decline in operating profit in H1 2023. Similarly, the operating profit margin has fallen to a paltry 0.7% from 4.8% in H1 2022.
The company also reported a net loss attributable to common shareholders during the first half of 2023, which is actually a reversal of the trend from the same time last year. If it had managed to maintain its operating profit at last year’s level (see table above), this would not be the case. At the same time, it continues the trend from the whole of 2022, where SunCar Technology reported a loss due to performance weakness in the 2nd half of 2022.
Positive sales prospects
The surplus picture is particularly disappointing given that China’s inflation numbers have been unusually subdued this year, even as the rest of the world is still struggling above comfortable inflation levels. In fact, in recent months the country has actually fallen into deflation (see chart below).
While it is understandable that a growing company like SunCar Technology needs to spend on research and development to develop and maintain a competitive edge for its software and technology services, the fact is that all other expenses, except for general and administrative expenses, are also growing in double digits . .
This makes a weak argument for profit growth in the foreseeable future. Well-spent expenses can, however, continue to support revenue growth. And there is already evidence of continued expansion for the company. After signing or renewing contracts for insurance brokerage services with electric car makers such as NIO ( NIO ), JIDU Auto and Li Auto ( LI ) this year, it also continues to expand into the financial sector.
For example, it entered into a three-year driving service agreement with CITIC Bank. It has also renewed contracts with Bank of Communications Limited, which is China’s fifth largest bank, for overseas car pickups covering 213 international airports.
If I start from the positive sales outlook, if I assume here that the company’s growth in the 2nd half of 2023 would be 34%, the historical compound annual growth rate [CAGR] for 2015-22 (see chart above on historical revenue). This results in a growth estimate of 31.2% for the full year 2023.
Market multiples are positive
This in turn results in a forward price-to-sales (P/S) ratio of 1.43x, which is positive compared to the last 12 months. [TTM] P/S of 1.67x. But both of its ratios are competitive compared to its peer, Autohome ( ATHM ), which enables auto-related transactions in China. Both ATHM’s forward and TTM P/S ratios are at 3.36x.
However, there is reason why AHTM trades at a premium compared to SDA. It was publicly listed way back in 2013. As a result, it has a longer available track record of performance. Over the past decade, its revenue has grown at a CAGR of 21.2% and its EPS at 16.1%. Notably, it did not fall into losses even through the extended COVID-19 challenge in China.
This still leaves the question of what the SDA’s fair value should be. For this assessment, let’s also consider the TTM P/S for the consumer discretionary sector at 0.84x and the forward P/S at 0.83x. Clearly, SDA is trading at a higher level than the average consumer discretionary stock. There is of course a good reason for that. It is in the growing Chinese market, which is also a large car market. So there is an argument for its rapid expansion, which may not be true of all other consumer discretionary stocks.
To arrive at SDA’s fair value, I have averaged the P/S ratio of ATHM and the median ratio of consumer discretionary stocks. This exercise indicates that there is at least 20-25% upside for SDA right now.
This indicates that, at least in the near term, SunCar Technology could see a price improvement to the extent indicated above. However, in the medium to long term, it is still best kept on the investment watchlist for now.
This is because its valuations are clearly subject to change, as evidenced by the subsequent offer at a lower price. With profit weakness visible this year, albeit on expenses that could boost sales growth, it’s also harder to make a medium-term case for it. From this perspective, I would go with a Hold rating on SDA.
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