Secoo Holding Ltd: 5 Reasons to Buy, 3 Reasons to Avoid

Markets Motley Fool

Chinese luxury e-tailer Secoo (NASDAQ: SECO) went public on Sep. 22 at $13 per share, but the stock stumbled and finished its first day at just $10. The broken IPO stabilized a few days later, but remains well below its initial price.

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Therefore, speculative investors might be wondering if Secoo is poised to rebound over the next few weeks. I personally own a small position in Secoo, so today I'll examine five reasons to buy this stock, and three reasons to avoid it.

Five reasons to buy Secoo

Secoo controls 25% of China's upscale e-commerce market, making it the largest luxury e-tailer in China. This means that it's well-poised to profit from the growth of China's middle class and rising internet penetration rates.

Secoo has grown its niche against e-commerce giants like Alibaba's (NYSE: BABA) Tmall and JD.com (NASDAQ: JD) as those larger marketplaces frequently struggle with monitoring counterfeit goods. To guarantee that its products are genuine, Secoo holds authorized distribution partnerships with top luxury brands like Versace, Dior, and Ferragamo.

Secoo usually targets second, third, and fourth-tier cities that have rising income levels but aren't adequately served by top luxury brands. That strategy is paying off -- Secoo's registered users grew 42% annually to 15.1 million in the first six months of 2017, with an average order per customer of 3,500 yuan ($529) -- which is high relative to the average monthly salary of 5,630 yuan ($851).

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Secoo's total revenues rose 49% annually to 2.59 billion yuan ($392 million) last year, and its GMV (gross merchandise volume) jumped 35% to 3.47 billion yuan ($525 million). That momentum remains strong, with its revenue and GMV respectively rising 30% and 51% during the first half of the year.

Secoo reported a net loss of 45 million yuan ($6.8 million) last year, which was a huge improvement from a loss of 222 million yuan in 2015. It also reported a net profit of 52 milion yuan ($7.9 million) in the first half of 2017, indicating that it could post an annual profit this year.

Three reasons to avoid Secoo

Secoo's IPO price valued the company at 1.7 times sales. That ratio was much lower than Alibaba's P/S ratio of 17, but it was higher than JD's ratio of 1.3. Alibaba might deserve that premium valuation -- it's the country's top e-commerce player and it's consistently profitable -- but Secoo hasn't proven itself or reported a full-year profit yet. That's why, at $10 per share, the market now values Secoo at about 1.3 times sales -- and it probably won't attract a higher valuation until it reports a few quarters of sustainable growth.

Secoo also faces tough competition from first-party luxury brands and other e-tailers. Gucci and Louis Vuitton's direct-to-consumer e-commerce platforms could threaten its long-term growth as they expand their logistics. Tmall recently launched a "luxury pavilion" storefront to showcase its top high-end brands, and JD acquired a stake in luxury e-tailer Farfetch to expand its upscale offerings. Tencent's WeChat, the top messaging app in China, also convinced brands like Louis Vuitton and Burberry to sell their goods within its fledgling e-commerce ecosystem.

Lastly, Secoo burns through a lot of cash. Its cash and equivalents plunged from 285 million yuan ($43 million) to 56 million yuan ($8 million) between fiscal 2015 and 2016, then slipped to just $5 million at the end of its second quarter. Secoo raised over $110 million from its IPO, but it's unclear how long that cash will last -- which raises the troubling possibility of a secondary offering.

The key takeaways

Secoo had a rough market debut, but it's probably just because the IPO was priced too high. It's still a speculative stock and the company faces tough competition, but it's survived assaults on its niche before. While smaller rivals like Xiu.com gradually faded away, Secoo has emerged as the top luxury e-tailer for China's growing middle class in neglected cities -- and that reputation could make the stock a good long-term play.

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Leo Sun owns shares of Secoo Holding Limited-ADR and Tencent Holdings. The Motley Fool owns shares of and recommends JD.com. The Motley Fool has a disclosure policy.