Singapore-based technology company Sea Ltd. (SE, Financial) faces significant headwinds amid various downgrades from Wall Street analysts following its second-quarter earnings results.
Market sentiment often dominates reality as the momentum of the masses is difficult to deflect. However, in an attempt to assess the velocity and sustainability of the sentiment, I decided to do a deeper dive into the status of Sea's salient variables.
Details of the bearish calls from Wall Street
Sea experienced two noticeable downgrades from Wall Street after its second-quarter earnings release. The first downgrade was from Citigroup Inc. (C, Financial), based on a top-down vantage point.
Citigroup's Alicia Yap adjusted Sea's target price to $50 per share from a previous $98, citing that the company's battle to maintain its market share is starting. In my view, Yap's analysis is objective as industry consolidation will likely occur as the company matures; on the other end, Singapore's consumer internet industry is set for an 11.70% annualized growth rate until 2027, which balances out her take.
Further, JPMorgan Chase & Co. (JPM, Financial) analyst Ranjan Sharma downgraded the stock to neutral from overweight and assigned a price target of $45.
According to Sharma, "SE's decision to accelerate e-commerce investments in growth is likely to materially weigh on its earnings and share price in the near term." He added that the company "could potentially incur heavy investments in 2H23 resulting in earnings decline in [the second-half]."
Sharma's argument is somewhat questionable. I say this because although the stock market tends to price structural earnings slumps, it typically does not consider short-term reinvestment-driven cost restructurings disadvantageous. Nevertheless, JPMorgan Chase's outlook might have a significant impact on the market, regardless of the ground truth.
Sea's second-quarter earnings miss
Sea's stock shed more than a quarter of its market value on the morning of Aug. 15 after its second-quarter earnings report was publically disseminated. The stock has not recovered since then, remaining at a similar price leval, suggesting the market is bearish on the asset and that post-earnings trading probably was not an overreaction.
It is unclear why Sea's stock dropped. The company surpassed its earnings estimate by 8 cents per share. Sure, second-quarter revenue fell short by $152.14 million, but still experienced 5.2% year-over-year growth during a trying economic period.
Dissecting the results
Let's dissect Sea's second-quarter results.
Sea reported a second-quarter gross profit of $1.5 billion, a 33.1% increase. Moreover, the company turned a profit of $331 million, a significant contrast to its loss of $931.2 million a year ago.
Much of the company's growth stemmed from its Digital Financial Services segment, which achieved $427.9 million in quarterly revenue, displaying year-over-year growth worth 53.4%.
Further, although Sea's digital entertainment revenue receded by 1.9%, its e-commerce sales remained robust, tabling 20.6% in year-over-year growth to achieve $2.1 billion in revenue.
In essence, Sea's sell-off seems overcooked, especially when considering how the quarterly results stack up against other companies in today's trying economy.
Key drivers
As mentioned earlier, Sea is participating in an industry that is set to grow at a compound annual rate of 11.70% until 2027. In addition, as illustrated in the diagram below, Singapore's economic trend growth is forecasted to stay above 2% per year until 2028, providing an additional tailwind to the company, especially as much of the economic growth is forecasted to stem from developments within the technology sector.
Source: Statista
Another factor to consider is Sea's potential to achieve synergetic growth. For instance, the company's e-commerce and digital financial services could coalesce and create cost-cutting paired with cross-sales synergies. Although Yap of Citigroup argues its market share will be tested, I believe we should consider that few regional consumer technology companies have established the level of synergies that Sea has.
Valuation
A collective assessment of Sea's valuation metrics paints a worrisome picture. First, the stock's price-sales ratio of 1.72 ranks within the 32nd industry percentile, suggesting a relative value mismatch. On top of that, the earnings yield of 2.17% is unconvincing for a growth stock.
Many might wonder why I outlined the stock's price-to-sales and earnings yield, in particular.
Well, the rationale behind it is to consider that Sea is a growth stock, in which case, profitability metrics such as the price-earnings and price-book ratios provide little input. In fact, a top-line observation or growth metrics such as the earnings yield provide far better insight.
Final word
The negative outlook on Sea from Wall Street analysts and investors can be contested by observing the finer details of the company's results. Despite its worrisome valuation metrics, the stock's recent sell-off seems unjustified, especially given the aforementioned factors coupled with the synergies embedded into its business model.
