Lemon_tm/iStock via Getty Images
Lemon_tm/iStock via Getty Images
I assign a Hold investment rating to Zhihu Inc.’s (NYSE:ZH) [2390:HK] stock.
Zhihu still delivered positive revenue growth in the recent quarter, and its forward price-to-sales metric has fallen to as low as 1.1 times. But this still isn’t the time to have a Bullish view of ZH. Investors need to consider that Zhihu remains loss-making, with more modest topline expansion prospects in the second half of the year. As such, it is more appropriate to rate ZH as a Hold instead of a Buy.
Zhihu describes itself as “the largest Q&A-inspired online content community in China” in the company’s press releases, while Bloomberg refers to ZH as “China’s answer to online Q&A service Quora.”
The company derived 39%, 33%, and 23% of its fiscal 2021 topline from advertising services, content-commerce solutions, and paid membership services, respectively, as disclosed in its FY 2021 20-F filing.
It is easy to understand what advertising and paid membership revenues refer to, as these are the usual means by which online platform operators make their money. With respect to content-commerce solutions, Zhihu defines this revenue stream as “offering merchants and brands with online marketing solutions that are seamlessly integrated into our online content community” in its fiscal 2021 20-F filing.
The remaining 5% of Zhihu’s FY 2021 revenue comes from other services, including but not limited to, e-commerce and vocational training.
Revenue for Zhihu’s advertising business declined by -4.3% YoY from RMB248.3 million in the second quarter of 2021 to RMB237.6 million for the most recent quarter, as highlighted in its Q2 2022 earnings media release.
The advertising business was the weak spot for ZH in Q2 2022, as Zhihu’s paid membership services and content-commerce solutions business lines both generated positive revenue growth during the same period. As a result of the topline contraction for the advertising service line, ZH’s overall revenue growth on a YoY basis moderated from +55.4% in Q1 2022 to +31.0% for Q2 2022.
ZH indicated at its Q2 2022 investor briefing that “advertisers and business partners (in China) became more cautious in online marketing spending”, in view of the fact that “many industries were heavily impacted by the ongoing COVID-19 outbreaks and softer macro environment” in the country. Lackluster advertising demand in China explains why the sell-side analysts are expecting Zhihu’s topline expansion to be even slower in the second half of the year.
According to the market’s consensus financial forecasts obtained from S&P Capital IQ, ZH’s projected YoY revenue growth rates for Q3 2022 and Q4 2022 are +9.3% and +12.5%, respectively. In the absence of indicators that Mainland China is ready to abandon its zero-COVID policy, the sell-side’s consensus financial estimates for Zhihu appear to be realistic.
Zhihu’s financial performance for the second quarter of 2022 could have been even worse, if not for the company’s efforts in revenue diversification. As per its FY 2021 20-F filing, ZH used to earn as much as 86% of its total revenue from advertising services in FY 2019. I mentioned earlier in this article that the revenue contribution of advertising services as a proportion of Zhihu’s topline has fallen to 39% last year.
In the next section, I touch on a significant growth driver for ZH in the intermediate term, as the company continues to diversify its revenue base.
ZH tweaked its financial reporting format with its Q2 2022 results announcement. Specifically, revenue earned from vocational training is now disclosed as a separate line item in Zhihu’s financial statements; vocational training used to be categorized under the other revenue line.
This small but meaningful change sends a clear signal to investors that Zhihu thinks that vocational training will become a substantial revenue contributor similar to advertising services, paid membership services and content-commerce solutions in time to come. In the most recent quarter, vocational training revenue for Zhihu was RMB46.1 million, which represented a +599% jump on a YoY basis as compared to the company’s Q2 2021 vocational training revenue of just RMB6.6 million.
In its fiscal 2021 20-F filing, Zhihu highlights that it offers “self-developed vocational training products and services, in addition to third-party vocational training courses” as part of its vocational training business.
At its second-quarter earnings call, Zhihu revealed that it “launched an online learning portal on our website to further promote our vocational training related content portfolio” in June 2022, and indicated that “the learning portal has been well received.” With vocational training representing a mere 5.5% of the company’s overall Q2 2022 topline, there is lots of potential for this business to generate higher revenue for ZH in the future with other new initiatives similar to the new online learning portal.
Zhihu’s consensus forward next twelve months’ price-to-sales valuation multiple has compressed from its late-June 2021 peak of 14.1 times to 1.1 times now based on S&P Capital IQ data.
Vocational training does seem to be a decent growth driver for ZH in the mid-to-long term, but investors are now much more concerned with the company’s revenue growth deceleration for 2H 2022 as discussed above. As such, the market has chosen to “penalize” Zhihu for its expected topline growth moderation in Q3 2022 and Q4 2022 by valuing the stock at a much lower valuation multiple.
It doesn’t help that Zhihu is unprofitable. In the current environment, investors in general have a preference for listed companies which are able to generate positive earnings, and ZH doesn’t fall into this category. In the first half of 2022, Zhihu suffered from an operating loss of -RMB1.1 billion.
Both analysts and management don’t seem to think that ZH will turn profitable in the near term. Consensus financial data sourced from S&P Capital IQ indicates that Zhihu will continue to be loss-making at the operating income level for the next two quarters, and ZH is expected to become profitable by fiscal 2026.
Separately, ZH’s management noted at the company’s Q2 2022 earnings briefing that “we will continue to implement prudent cost controls to achieve a rational balance between user growth and the profitability in the long run.” In other words, this seems to imply that short-term profitability will be less likely for the company as Zhihu continues to invest to expand its user base.
In a nutshell, I think Zhihu’s valuation de-rating is fair.
Zhihu’s stock is rated as a Hold. The key positives for Zhihu are its low forward price-to-sales multiple of 1.1 times, and the growth potential of vocational training. On the flip side, ZH’s negatives are that the company is expected to experience slower topline expansion and continued losses in the short term. In conclusion, the risk-reward for ZH is rather balanced at this point in time, which warrants a Hold rating for the stock.
Asia Value & Moat Stocks is a research service for value investors seeking Asia-listed stocks with a huge gap between price and intrinsic value, leaning towards deep value balance sheet bargains (i.e., buying assets at a discount, e.g., net cash stocks, net-nets, low P/B stocks, sum-of-the-parts discounts) and wide moat stocks (i.e., buying earnings power at a discount in great companies like "Magic Formula" stocks, high-quality businesses, hidden champions and wide moat compounders). Sign up here to get started today!
This article was written by
Those who believe that the pendulum will move in one direction forever or reside at an extreme forever eventually will lose huge sums. Those who understand the pendulum’s behavior can benefit enormously. ~ Howard Marks
Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
About Author
