iHuman Leaves Investors Unimpressed With Flat Margins, Slow Revenue Growth

Key Takeaways:

• iHuman’s revenue grew 9% in the first quarter, while its profit quadrupled as it controlled costs with a sharp drop in R&D spending
• The maker of children’s “edutainment” apps has launched two new initiatives over the last year to tap the international market, but has yet to record significant revenue from those

By Doug Young

Maybe it was the flatness of its margins, despite triple-digit profit growth and revenue growth that came tantalizingly close to double-digits.

That’s our potential explanation for the notable lack of excitement following the release of iHuman Inc.’s IH latest quarterly financial report on Wednesday. Two days after the announcement, the stock was unchanged from where it closed the day before the company unveiled its latest quarterly report.

Perhaps the lack of excitement is a good thing these days, given that iHuman operates in China’s sensitive education sector that was subject to a major crackdown two years ago that wiped out an entire industry providing after-school tutoring services for K-12 students. iHuman was largely spared in that crackdown, since it operates in a different space offering “edutainment” apps that help kids improve themselves in areas like reading and logic.

Still, iHuman notes in its latest annual report that one of its major risks is the potential for future crackdowns if Beijing decides to ban or limit its products. Accordingly, the company is working to develop its international business that wouldn’t be affected by such crackdowns. That international push was one of the more interesting elements in the company’s latest quarterly report, which mostly reflected the continuation of recent company trends.

All that said, this company looks relatively well situated in its space providing mostly online apps that can help kids improve themselves.

The company’s founder and Chairman Chi Yufeng and CEO Dai Peng both have deep experience in China’s education and gaming space, much of it related to their previous roles at Perfect World(002624.SZ), one of China’s earlier gaming leaders. Its biggest problem lies in its relatively slow growth, even as the company became profitable last year.

iHuman’s revenue growth picked up a bit to 9.3% in this year’s first quarter year-on-year, reaching 265.2 million yuan ($37 million) in the latest period from 242.7 million yuan a year ago. That was more than double the 4.3% revenue growth rate the company reported for all of last year, though it was well behind the roughly doubling of revenue in each of the previous two years.

At least part of the slowdown owes to iHuman’s own strategic shift to providing online services, compared with its previous mix that also had a large component of offline products and services that typically carry lower margins. As it makes that shift, the company said that less than 10% of its revenue came from offline products and services in 2022.

Like many Chinese companies, iHuman has been focused in the last two years on reducing its spending and operating profitably over a previous strategy of growth at any cost. It continued that pattern in the first quarter, with its operating expenses dropping 18.8% year-on-year to 128.8 million yuan, mostly due to a 36% drop in its R&D spending.

Those cost controls, combined with the modest revenue gains, helped iHuman’s profit quadruple to a record 53.6 million yuan in the first quarter from 13.1 million yuan a year earlier.

Stagnant Margins

Despite those positive gains, one thing that has remained stubbornly unchanged over the last few years is iHuman’s gross margin, which is one of the best indicators of its profitability. The figure stood at 70% in the latest quarter, which isn’t bad, but was unchanged from a year ago. And despite the company’s steady move to more profitable online services, the latest margin is only up slightly from 68.7% in 2020.

In fact, such margin stagnation wouldn’t be such a problem if the company could scale up its business more rapidly and return to some of its earlier revenue growth rates. One area that could help in that regard is its international business, which dates back to the launch of its Bekids brand in last year’s second quarter. That brand offers subjects like coding, coloring, science and reading.

More recently, the company launched another kids app, Aha World, in the fourth quarter of last year. That app appears to draw more on the gaming roots of iHuman’s top executives, described as an “open-ended fantasy adventure-themed app.”

iHuman said in its latest results that Aha World entered the top 10 children’s apps in both the Apple and Google Play app stores after its launch. Perhaps that was the case at some point, though the app currently ranks 79th among education apps on the Apple app store, and wasn’t among the top downloaded kids’ apps on Google Play either. But Rome wasn’t built in a day.

More importantly, iHuman didn’t break out international revenue as a separate category in its latest quarterly report, nor did it in its 2022 annual report released in late April. That indicates the figure is probably still relatively minor, mostly likely well below 10% of its total. But it could certainly become an important contributor in the future, and would help the company to diversify away from its heavy reliance on the fickler China market.

Within China, the company also disclosed that it formed a new partnership during the first quarter with Post & Telecom Press and its Children’s Fun Publishing Co. Ltd. affiliate, which is a major Chinese children’s book publisher. While that may not sound too exciting, the alliance with such a major state-owned entity could help iHuman to navigate any potential regulatory risks in the future, and seems to signal the company isn’t facing any immediate danger from such risk.

Despite all that, investors clearly want more from the company than they’re currently getting. iHuman’s stock currently trades at a price-to-sales (P/S) ratio of just 1.12, which is just barely above the 1 mark that generally indicates positive investor sentiment. Its figure is roughly equal to the 1.15 ratio for 17 Education YQ, which is retooling after getting caught up in the crackdown two years ago. It’s also behind the 1.22 for the recently listed QuantaSing QSG, which focuses on adult learning but is still losing money.

At the end of they day, iHuman seems to have a decent business model and is boosting its prospects with its new publishing partnership at home and its attempts to build up an international business. Now it just needs to start reaping some rewards from those efforts with a return to faster revenue growth.