Sea Limited: Could Be Stuck Here For A While

May 17, 2022 4:07 PM ETSea Limited (SE)34 Comments5 Likes

Summary

  • Sea Limited reported its FQ1 earnings results that beat the consensus estimates on revenue and EPS. It was a relief as SE stock was battered over the past six months.
  • However, we are concerned over Garena's slowing growth. Furthermore, Shopee's guidance range was also widened due to inflation, and macro headwinds.
  • The company is also still unprofitable, even as it scales Shopee up rapidly to improve efficiencies. We think the stock is likely to move sideways in FY22.
  • We reiterate our Hold rating with a PT of $90, as the risk/reward profile remains challenging.
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Shopee headquarters in Singapore

kokkai/iStock Unreleased via Getty Images

Investment Thesis

Sea Limited (NYSE:SE) reported its FQ1 earnings card to some fanfare as investors cheered its better than expected results. Sea reported revenue and EPS ahead of consensus estimates in Q1. However, the company also tempered investors' expectations in its e-commerce arm, Shopee, as it widened its guidance range. Notably, the company sees potential headwinds emanating from higher inflation, macro risks, and the reopening of the Southeast Asian economies.

Our analysis of the consensus estimates suggests that they have been revised downwards due to the lackluster performances from its US e-commerce peers recently. We think the beat was reassuring. But, Sea Limited is charting a new (slower growth) phase that could be challenging to execute, given the macro and micro headwinds. Therefore, we believe the stock is likely to trade within a consolidation range throughout FY22 as the market parses its execution.

Furthermore, our price action analysis indicates that the stock could still face a potential "ultimate" bottom test, with several layers of resistance to impede its re-rating. As a result, we reiterate our Hold rating on SE stock for now, with a price target (PT) of $90 (implied upside of 12.5% at writing).

Beat Consensus, But Widened Guidance Range for Shopee

Sea Limited revenue change % and Adj. EBITDA margins % consensus estimates

Sea Limited revenue change % and Adj. EBITDA margins % consensus estimates (S&P Capital IQ)

Sea Limited EPS consensus estimates

Sea Limited EPS consensus estimates (S&P Capital IQ)

Sea reported revenue of $2.9B, up 64.4% YoY (Vs. Consensus estimates of $2.86B, up 62.1% YoY). Notably, it reported a lower than expected loss on GAAP and adjusted EPS terms. Sea posted GAAP EPS of -$1.04 (Vs. consensus estimates of -$1.40) and adjusted EPS of -$0.80 (Vs. consensus estimates of -$1.22).

Although the sequential revenue growth deceleration was concerning, we were satisfied with the inflection seen in its EPS metrics. As a result, we believe that the consensus estimates (from FQ2 onwards) could be revised subsequently to reflect Sea's stronger than estimated profitability performance.

Management also remains optimistic about achieving its original guidance of adjusted EBITDA profitability in Shopee (excluding HQ costs) in its key markets in FY22. Notably, it also emphasized that it could achieve adjusted EBITDA profitability (including HQ costs) by the end of FY23. We think the commentary is constructive on its path to adjusted profitability despite slowing topline growth.

But, Critical Headwinds Linger On

Garena Bookings

Garena Bookings (Company filings)

Garena Adj. EBITDA share of bookings %

Garena Adj. EBITDA share of bookings % (Company filings)

Its cash cow Garena continues to experience slowing growth as the economies reopen. Moreover, Sea also highlighted its growth had been impacted by its ban in India. As a result, Garena's Bookings growth slumped into negative territory, at -27% YoY in FQ1. Notably, management was reticent on whether they expected the slowdown to be structural or short-term. It asked for more time to observe the trends, given the shroud created by the reopening cadence. Sea Group CEO Forrest Li accentuated (edited):

As we navigate this pace of moderation, we are focused on user base stabilization. We saw some preliminary signs that this is starting to bear fruit with the monthly user trends for Free Fire beginning to show some early signs of stabilizing towards the end of the first quarter. While these are encouraging signs, the longer-term impact of reopening around online gaming and Free Fire specifically remains to be seen, and we will continue to focus on user engagement and user base stabilization. (Sea Limited's FQ1'22 earnings call)

Shopee GMV

Shopee GMV (Company filings)

Shopee Adj. EBITDA per order

Shopee Adj. EBITDA per order (Company filings)

Therefore, with a slowing cash cow funding Shopee's growth, the market was justifiably concerned about the impact of Sea's loss-making e-commerce unit. But, management reiterated that Shopee has continued to gain operating leverage as it expands its higher-margin services in transaction-based fees and advertising. Furthermore, it also continues to gain operating efficiencies in scale even as its gross orders fell from $2B in FQ4 to $1.9B in FQ1.

As seen above, Shopee's adjusted EBITDA loss per order improved to -$0.40 in FQ1. However, we remained concerned with its e-commerce guidance as management widened its guidance range. Sea Limited's revised FY22 guidance sees Shopee posts revenue between $8.5B to $9.1B. It was revised from its previous guidance of $8.9B to $9.1B. At the midpoint of its guidance, Shopee is expected to post revenue of $8.8B (up 71% YoY), down from $9B (up 75.7% YoY).

Consequently, with slower topline growth, it could impact Shopee's ability to deliver its path to adjusted EBITDA profitability. Therefore, we urge investors to carefully monitor its progress over the next few quarters.

Is SE Stock a Buy, Sell, or Hold?

SE stock price chart

SE stock price chart (TradingView)

SE stock NTM FCF yields % and NTM normalized P/E

SE stock NTM FCF yields % and NTM normalized P/E (TIKR)

SE stock still trades at negative normalized P/E and FCF yields. Therefore, investors must have high conviction over the company's ability to scale up Shopee while turning the corner in Garena. While Sea Money has made encouraging progress, we think it's not significant enough to move the needle. Garena and Shopee will continue to drive the momentum in SE stock in the near term.

In addition, our price action analysis of SE stock shows badly damaged technicals, filled with a series of astute bull traps. Furthermore, these traps are also overlaid with several critical layers of resistance that could impede SE stock's recovery momentum moving forward.

While we don't think investors should bail out of SE stock now, we don't see a well-balanced risk/reward profile now for SE stock either. Therefore, we urge investors to bide their time and wait for a consolidation phase before adding exposure.

We reiterate our Hold rating on SE stock with a PT of $90.

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This article was written by

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Sifting through the ultimate growth stocks for your portfolio

I'm Jere Wang, the lead writer and founder of JR Research and Ultimate Growth Investing Marketplace service. Our team is committed to bringing more clarity to investors in their investment decisions.

Our marketplace service focuses on a price-action-based approach to growth and technology stocks, supported by fundamental analysis. In addition, our general SA site discusses stocks from various sectors and industries. 

Our discussion mainly focuses on a short- to medium-term thesis. While we hold stocks for the long-term, we also use appropriate opportunities to benefit from short- to medium-term swings, leveraging long (directionally bullish) or short (directionally bearish) set-ups. 

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Disclosure: I/we have a beneficial long position in the shares of SE either through stock ownership, options, or other derivatives. 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.

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