Huya Still Looks Ridiculously Cheap Relative to Its Growth

MarketsMotley Fool

Chinese streaming-video company YY (NASDAQ: YY) spun off its video-game-streaming unit into a new company called Huya (NYSE: HUYA) with an IPO last May. Huya then impressed investors with five straight quarterly reports featuring massive revenue and earnings growth. The stock has nearly doubled since its debut.

Based on the first-quarter report it delivered on Thursday, Huya hasn't been fazed by the slowdown in the Chinese economy, the escalating trade war, or Beijing regulators' nine-month freeze on new video game approvals last year.

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Huya's revenue surged 93% annually to 1.63 billion yuan ($243.1 million) during the quarter. Its non-GAAP net income rose 94% to 131.3 million yuan ($19.6 million) and its GAAP net income more than doubled to 63.5 million yuan ($9.5 million). Yet the stock trades at less than 30 times forward earnings -- which seems ridiculously low relative to its earnings growth.

Tracking Huya's growth

The triple-digit percentage sales growth this company generated throughout fiscal 2018 couldn't last forever, so it wasn't surprising when it eventually decelerated somewhat.

Metric

Q1 2018

Q2 2018

Q3 2018

Q4 2018

Q1 2019

YOY revenue growth

112%

125%

119%

103%

93%

During Q1, Huya's average monthly active users (MAUs) grew 33% annually to 123.8 million. Its average mobile MAUs rose 30% to 53.9 million.

The company generated 95% of its revenue from sales of virtual gifts and items, which viewers purchase for their favorite broadcasters. The remaining 5% came from ad sales. Huya's main strategy is to convert its free viewers into paying users -- and it appears to be working. The numbers of customers buying virtual items rose 57% annually to 5.4 million during the quarter.

Huya expects its revenue to rise by 67% to 72% during Q2. It didn't provide full-year guidance, but analysts' consensus forecast is for its revenue to rise 51%.

Huya's cost of revenues rose 91% annually to 1.36 billion yuan ($202.4 million), mainly due to higher revenue-sharing fees with broadcasters, content costs, and bandwidth costs. Nonetheless, it has stayed profitable on a non-GAAP basis ever since its IPO, and Wall Street expects its earnings to rise 53% for the year.

Why is Huya trading at a discount to its growth?

Investors might be wary of Huya for three reasons. First, escalating trade tensions and mixed economic reports out of China are causing investors to shy away from all Chinese stocks -- regardless of their quality.

Second, Huya's growth is decelerating, and it's unclear when that slowdown will flatten out. If the company's cost of revenues starts climbing at a faster rate than its total revenue growth, its streak of profitability could abruptly end.

Lastly, its biggest competitor, Douyu, plans to go public soon. Douyu reaches a larger audience than Huya, and its MAUs grew 26% annually to 159.2 million MAUs last quarter, while its total paid users jumped 67% to 6 million.

However, Douyu hosts more non-gaming videos than Huya, and esports viewers accounted for about 60% of its MAUs at the end of 2018. Therefore, Huya remains the largest pure play on video game streaming in China, the world's largest video game market.

An undervalued growth stock

Huya's growth may be slowing down a bit, but it's aggressively converting free users to paid ones, and expanding its margins. It reported a non-GAAP gross margin of 17% for Q1, which was up 140 basis points annually and 90 basis points sequentially.

It's also worth noting that one of Huya's biggest backers is Tencent (NASDAQOTH: TCEHY), the world's biggest video game publisher. Tencent also backs Douyu, and it recently introduced new measures to prevent the two from poaching broadcasters from each other. That friendly interference could enable both platforms to grow without trampling the other.

Huya certainly isn't a stock for conservative investors. However, for those in search of undervalued growth stocks that could pop on any good news from China should keep a close eye on what has come to be known as the "Twitch of China."

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Leo Sun owns shares of Tencent Holdings. The Motley Fool owns shares of and recommends Tencent Holdings. The Motley Fool recommends HUYA Inc. The Motley Fool has a disclosure policy.