Will Wall Street Notice Gmarket's Remarkable Margin Expansion?

At a time when most companies outside the energy/material complex show declining margins, the leading online retailer in South Korea continues to expand margins at a fast clip. Gmarket (GMKT) reported on 7/29 that Q2 operating margins expanded nearly 300 basis points from 15.9% to 18.8% over Q1 and 500+ basis points over last years 13.6%. This growth lead to $0.30 earnings (or roughly $0.27 excluding a tax benefit) which far exceeded the $0.21 analyst estimate.

Q2 Highlights

• Revenue up 26%
• Advertising revenue up 39%
• Operating income up 74%
• Net income up 91%

Ignore the headlines that revenue missed, as revenue was up 10% in the local Korean Won and was only impacted in the translation to the weak dollar. In fact, analysts only forecast 17% growth, which was easily surpassed by the 26% growth.

The real key takeaway is that advertising continues to soar and is quickly heading to 50% of total revenue. Ad growth is a major contributor to the margin expansion, along with continued operational efficiency.

In addition, due to strong market recognition, GMKT has been able to grow customers and users without increasing the sales and marketing budget. Ad revenue continues to grow at a much faster clip then transaction volume, which should lead to higher revenue growth as ad becomes a larger part of the top company.

With only 53K shares traded on the day of earnings, the real question remains whether Wall Street will even notice this astounding margin expansion. At a time when the market is willing to pay an outlandish multiple for Amazon (AMZN), which has has very low margins, and companies like Baidu (BIDU) and Google (GOOG) have huge market recognition because of strong online ad revenue, it's amazing that GMKT is so underfollowed. Will this be the quarter that draws more attention and hence a higher multiple? Usually 18.8% operating margins does the trick, but first they'll have to notice.

Based on the reported $0.50 in the 1H of '08, and the fact that the 2H is always stronger with the holiday shopping season, the revised earnings for '08 could easily match the current $1.10 for '09 and clearly greatly exceed the current $0.87 estimate. As analysts recalculate their estimates, maybe GMKT will finally get the focus it deserves.

Disclosure: Author holds a long position in GMKT