Meitu Finds Beauty In Growing Profits

Key Takeaways:

• Meitu expects to post a net profit of 220 million yuan to 260 million yuan in the first half of the year, reversing a 266 million yuan loss a year earlier
• The beauty company posted its first net profit last year after shifting its focus to business-oriented services rather than services targeting consumers

By Doug Young

After a long and difficult adolescence, is beauty services provider Meitu Inc. (1357.HK) finally set to become the belle of the ball?

Early signs appear to point that way, at least based on the company’s latest financials and its growing love affair with investors. The latest blossoming for this former ugly duckling was on display in an announcement last week showing Meitu’s early flirtation with profits could be the start of yet another new love affair.

OK, perhaps we’re overdoing it just a tad with all the metaphors drawing on the classic tale of an ugly duckling who later matures into a beautiful swan. But that comparison really does seem to apply here, largely due to Meitu’s realization several years ago that being popular doesn’t really matter if nobody pays for your services.

The company started out as operator of a wildly popular beauty app that let people doll up images of themselves to share with friends. But that basic service was free and Meitu didn’t have much luck convincing the aspiring beauties who used its app to fork over extra money for value-added services. As a result, the company’s main revenue source for most of its life was advertising, which paid some of its bills but not enough to put the company into the black.

Then Meitu realized something that many in the business world have known for ages: Businesses are much more willing to spend money than ordinary consumers. Armed with that new knowledge, Meitu shifted its focus to selling its beauty services to stores like cosmetics shops, for example, by providing them with software to help customers try on makeup virtually.

More recently Meitu has added software as a service (SaaS) to its product lineup, again targeting shops that are more than happy to pay because they see such services as an investment to improve their own business.

The older beauty services for businesses, known in Meitu’s financial reports as VIP subscription services, have grown rapidly and became the company’s biggest breadwinner last year, overtaking advertising. SaaS is growing even faster, and could also overtake advertising to become Meitu’s second-largest revenue source this year if current trends continue.

In the course of its transformation, Meitu recorded its first-ever adjusted profit, which excludes one-time items like investment gains and stock-based employee compensation, in 2021. It went on to record its first-ever net profit last year.

Now squarely in the black, Meitu disclosed in its latest announcement that it that it expects to report a net profit attributable to owners of the company of 220 million yuan ($30 million) to 265 million yuan in the first half of this year, a mirror image of the 266 million yuan loss it reported in the year-ago period. It added it expects to report an adjusted profit of 140 million yuan to 155 million yuan for the six-month period, up from a 36 million yuan adjusted profit a year earlier.

It attributed the profit gains to strong growth for its VIP subscription business, adding that one-time gains related to a cryptocurrency investment helped to fuel the larger net profit growth.

Investor Love Affair

Investors fawned over the profit alert, at least initially, bidding up Meitu’s shares by 2.9% the first trading day after the announcement’s release. But perhaps they’d had just a little too much of this new beauty queen lately, as the stock sagged in the next two trading days and was actually down 7% from pre-announcement levels at Thursday’s close of HK$2.90.

Short-term trends aside, Meitu’s stock is definitely picking up new admirers. The shares have nearly doubled so far this year, and have tripled over the last 52 weeks. But lest anyone forget, the stock originally sold for HK$8.50 at the time of the company’s 2016 IPO when investors were more interested in its big user numbers and less concerned about profits.

That said, the company has a relatively attractive price-to-earnings (P/E) valuation of 21 using net profits from the last 12 months, and the ratio jumps sharply to 58 if we use the adjusted profit figures. Those compare favorably to the 23 for Perfect Medical (1830.HK) and 39 for Beauty Farm(2373.HK), which operate brick-and-mortar beauty shops that are some of Meitu’s customers.

We could argue that Meitu probably deserves a higher valuation than these brick-and-mortar operators due to its easier scalability. That potential for rapid expansion is evident in its 2022 annual report, which shows the company’s revenue growth accelerated to 30% in the second half of the year from 20% in the first half, based on our calculations.

As we’ve previously noted, VIP subscription revenue grew by 57% for all of last year to 782 million yuan, overtaking advertising to become the company’s biggest revenue source, accounting for 38% of the year’s total. By comparison, advertising revenue actually fell 22.2% for the year to 596 million, reflecting a broader cutback in marketing activity by many companies during last year’s strict Covid controls in China.

Revenue from SaaS grew the fastest, rising more than tenfold to 463 million yuan, accounting for 22% of total sales. But notably, Meitu pointed out its overall gross margin fell sharply last year, dropping 10.6 percentage points to 56.9% from 67.5% in 2021. It blamed that decline on lower margins for SaaS as it focused on building up that business over earnings big profits.

Last but not least, we should comment quickly on the cryptocurrencies that briefly got Meitu into big trouble when it took a chance on that volatile asset class a couple of years ago, in what looked like an attempt to make some quick money to become profitable. The company ended up posting big losses instead when the crypto market crashed last year, and we’re happy to report it appears to have learned its lesson, albeit the hard way.

“Since the cryptocurrencies acquisitions in March and April 2021, the group has neither acquired nor sold any cryptocurrencies pursuant to the cryptocurrency investment plan,” Meitu said in its latest profit alert, in yet another sign that this former ugly duckling is finally growing up.