Broker’s Call: Sea Ltd’s Focus on Profitability Pays Off, Upgrade to Add

CGS-CIMB Analyst take

Growth stocks have taken a veritable beating so far in 2022. That’s come as interest rates have risen and longer duration assets have suffered.

Among those high-growth stocks that saw pandemic gains was Southeast Asia-focused e-commerce and gaming giant Sea Ltd (NYSE: SE).

However, its shares have been hit hard as its stock price has fallen by more than 70% so far this year. There was some respite for investors as Sea reported Q3 2022 earnings yesterday (15 November).

Sea shares went on to soar 36% in response as the company focuses on its path to profitability.

The research team at CGS-CIMB Securities upgrades our recommendation on Sea Ltd to “ADD” and we adjust our target price upwards to US$75 (from US$61 previously).

For growth investors in Singapore, here are some of the key points from Sea Ltd’s latest numbers.

Sea Q3 2022 sees sharp narrowing of losses

A strategic shift to focus on profitability has started to bear fruit for Sea. The company’s Q3 2022 non-GAAP net loss of US$370 million was down 35% quarter-on-quarter and 18% year-on-year.

That came in 20%/25% narrower than our/Bloomberg consensus forecasts.

While this has resulted in a slowdown in revenue growth, Sea’s GAAP revenue of US$3.2 billion – up 7% quarter-on-quarter and 17% year-on-year – was in line with expectations.

The significant narrowing of losses at Shopee and Sea Money more than offset the weakness in Garena, its digital gaming arm.

The losses would have been even narrower if the one-time severance package and early termination costs (amounting to US$85 million) were excluded.

Sea continues to focus on profitability and limiting its cash burn. It also reassured investors that it intends to achieve self-sufficiency without relying on any external funding.

Shopee Asia achieves positive contribution margin

While gross merchandise value (GMV) growth was flat quarter-on-quarter, the strong take-rate increase (up 90 basis points quarter on quarter) and optimism in sales and marketing expenses led to segment EBITDA losses narrowing by 24% quarter-on-quarter.

Indeed, Shopee’s Asia markets achieved a margin positive contribution in Q3 2022.

Sea now expects Shopee to reach adjusted EBITDA breakeven by the end of 2023, a year ahead of expectations.

However, this could come at the expense of weak GMV growth in the near term. Management will only look to reaccelerate growth in a more sustainable manner after achieving self-sufficiency.

SeaMoney shows healthy growth, gaming woes continue

Sea’s digital finance arm – SeaMoney – saw strong revenue growth of 147% year-on-year to US$327 million while adjusted EBITDA losses narrowed during the quarter.

That came from more disciplined spend on driving mobile wallet adoption and health profitability in its credit business.

Meanwhile, its gaming segment – Garena – was the only weak spot as booking further declined (down 7% quarter-on-quarter) and adjusted EBITDA also fell (down 13% quarter-on-quarter).

Sea noted that reopening trends continue to have a negative impact on user engagement, and game spend was further affected by macro uncertainties.

Bookings guidance for Garena for FY2022 was lowered to a range of US$2.6-2.8 billion (from US$2.9-3.1 billion), implying a further decline of 26% quarter-on-quarter in Q4 2022 – at the mid-point.

Upgrade from Hold to Add, higher target price of US$75

We upgrade Sea shares to Add from Hold given Shopee’s faster-than-expected narrowing of losses.

Our sums-of-the-part (SOP)-based target price is raised to US$75 with a higher target multiple of 2.9x FY2023 price-to-sales for e-commerce (from 2.0x).

Potential upside catalysts include resilient GMV numbers despite the profitability push and successful game launches.

On the downside, risks include a macro slowdown that impacts consumer spend in the region and thereby hurting Sea’s top line growth.

Disclaimer: CGS-CIMB Securities SMID Analyst KC Ong doesn’t own shares of any companies mentioned.