Kingsoft Cloud: Spotlight On Short-Term Headwinds And Profitability Guidance

Jun. 21, 2022 11:36 AM ETKingsoft Cloud Holdings Limited (KC)1 Like

Summary

  • Kingsoft Cloud's Q2 2022 revenue guidance was disappointing, and it is telling that KC didn't issue management guidance for full-year 2022 top-line expectations.
  • But I am positive about KC's future profitability, as the company expects to achieve EBITDA breakeven in the final quarter of 2022.
  • I think that Kingsoft Cloud warrants a Hold rating, after considering the outlook for both its revenue growth and profitability.
  • Looking for more investing ideas like this one? Get them exclusively at Asia Value & Moat Stocks. Learn More »

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Elevator Pitch

I have a Hold investment rating assigned to Kingsoft Cloud Holdings Limited's (NASDAQ:KC) shares. I discussed about KC's Q3 2021 management guidance and potential competition from the government in my prior article written on September 28, 2021.

My view of Kingsoft Cloud as a potential candidate is mixed. On one hand, I fear that the future revenue growth for its public cloud services and enterprise cloud services businesses might not live up to the market's expectations due to near-term headwinds. On the other hand, I think investors will view KC's expected profitability improvement in the future in a favorable light.

Short Term Headwinds

Kingsoft Cloud emphasized at the company's recent Q1 2022 results briefing on June 8, 2022 that "we are not providing official guidance for the full-year total revenue." At the same time, KC also guided for the company to deliver a top line of "between RMB2.0 billion and RMB2.2 billion" for the second quarter of 2022, which is equivalent to a YoY "growth of -8.0% to +1.2%" in its Q1 earnings press release. As a comparison, Kingsoft Cloud's revenue grew by +15% YoY in Q1 2022.

The lackluster Q2 2022 revenue guidance and the fact that the company declined to offer full-year top line sales forecasts suggest that Kingsoft Cloud is facing substantial headwinds in the short term.

KC has two main business segments, public cloud services and enterprise cloud services, which contributed 77% and 23% of the company's Q1 2022 revenue, respectively. Both businesses are facing significant challenges now.

The public cloud services business segment saw its revenue decline by -1% from RMB1,392 million in Q1 2021 to RMB1,381 million in Q1 2022. At the company's Q1 2022 investor call, Kingsoft Cloud explained that "budgets from Internet sector clients in general have been increasing at a slower pace than expected", and KC has "proactively downsized our CDN (Content Delivery Network) services and allocated more resources to core cloud services" since Q4 2021.

Specifically, the CDN sub-segment of the public cloud service businesses witnessed a -20% YoY decrease in its revenue in the first quarter of 2022. Also, the CDN business' revenue as a proportion of Kingsoft Cloud's top line has contracted from 50% in the past to 30% in Q1 2022.

On the other hand, the positive revenue growth momentum for KC's enterprise cloud services business in the first quarter is unlikely to be sustained.

Revenue for the enterprise cloud services segment surged by +89% YoY from RMB420 million in the first quarter of last year to RMB793 million in the most recent quarter. Looking forward to the second quarter, Kingsoft Cloud acknowledged at the company's Q1 2022 earnings briefing that COVID-19 lockdowns in China have resulted in "delays to project time lines and increases in delivery costs" for its enterprise cloud services projects.

Moving ahead, there are worries that KC's two key businesses might still be under pressure for a while, which could affect the company's overall revenue growth this year. Based on consensus financial forecasts obtained from S&P Capital IQ, Kingsoft Cloud's top line expansion is seen to moderate from +38% in fiscal 2021 to +7% in FY 2022.

The customers for the KC's public cloud services business are largely Chinese internet companies, and they aren't doing well with the Wall Street Journal reporting in March 2022 that the major technology firms in China have been reducing their workforce. Separately, the near-term growth prospects of Kingsoft Cloud's enterprise cloud services segment could be adversely impacted by the potential cut in the budgets of its clients as a result of broad economic weakness.

Profitability Guidance

It isn't all doom and gloom for Kingsoft Cloud.

As per the company's Q1 2022 results media release, KC guided that it "expects our adjusted gross margin will be higher in the second quarter than in first quarter" and sees its "adjusted EBITDA margin will breakeven in the fourth quarter of 2022."

The management guidance on profitability is largely aligned with the sell-side's consensus profit margin estimates. According to S&P Capital IQ, Kingsoft Cloud's gross profit margin is expected to expand from 3.8% in Q1 2022 to 4.5% in Q2 2022, prior to rising further to 5.7% and 7.3% for Q3 2022 and Q4 2022, respectively. KC is also expected to witness its losses at the EBITDA level narrowing from -RMB152 million in Q1 2022 to a marginal -RMB4 million in the final quarter of this year. The market's consensus financial projections also point to Kingsoft Cloud generating positive EBITDA for full-year FY 2023 and FY 2024 as well.

One key driver of the improvement in profitability for Kingsoft Cloud is expected to be the decrease in revenue contribution from the low margin CDN services business. As highlighted in the preceding section, the CDN services business accounted for 30% of KC's revenue in the first quarter of this year, as compared to a much higher 50% in the past. At its Q4 2021 results call on March 24, 2022, Kingsoft Cloud also revealed that it has been reallocating resources from its CDN services business to "to our higher-margin services, including computing, big data and database products and solutions." In other words, a more favorable revenue mix is likely to help KC achieve breakeven at the EBITDA level by the end of the year.

Other drivers of the profitability turnaround for Kingsoft Cloud include economies of scale and a greater emphasis on cost efficiency. Sell-side analysts expect KC's revenue to grow by +145% from RMB3,956 million in FY 2019 to RMB9,697 million in FY 2022, allowing KC to benefit from the positive effects of operating leverage associated with enhanced scale. Separately, Kingsoft Cloud commented at its Q1 2022 investor briefing that "our initiatives to cut costs and improve efficiency have delivered substantial results" in relation to gross margin improvement.

In a nutshell, it is encouraging that KC has outlined its expectations for improved profitability by the end of 2022. As the current market environment favors profitable companies over their loss-making peers, Kingsoft Cloud could potentially be in favor with some investors if it can achieve its EBITDA breakeven target for Q4 2022.

Closing Thoughts

There is significant uncertainty over Kingsoft Cloud's stock price outlook for the rest of 2022, which justifies a Hold rating for KC. Kingsoft Cloud is expected to experience slowing revenue growth this year, but this is offset by the fact that EBITDA losses for KC will narrow substantially by the fourth quarter of 2022.

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Asia Value & Moat Stocks is a research service for value investors searching for attractive Asia-listed investment opportunities  with a huge gap between price and intrinsic value, leaning towards both 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).


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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.

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