Focus Media: Rising in pessimism, is it a true recovery or a false rebound?

Hello everyone, I am Dolphin!

$Focus Media(002027.SZ) released its 2024 interim report on August 8th Beijing time. Since the first quarter is a known factor, Dolphin Jun will also focus on the marginal changes reflected in Q2.

Key points of the financial report:

1. Revenue significantly exceeds expectations? Market overly pessimistic: Focus Media's revenue in Q2 grew by 10%, significantly exceeding the market's expected 4%, and also surpassing Dolphin Jun's expectation of 5%-10% growth. The market's low expectations stem from the low base advantage in Q1, with a year-on-year growth rate of only 6%. This led the market to have difficulty in having normal or optimistic expectations for Q2, which carries the high base disadvantage and worse macro data.

In reality, if we only look at the growth rate in Q2, it basically aligns with the normal trend of a 10% price increase at the beginning of the year, which does not mean that the macro environment is much better than we imagine. As mentioned by Dolphin Jun in the Q1 review, the current environmental trends are complex, with factors such as price increases, the Olympics, and ongoing e-commerce competition providing relative advantages, so one should not be overly pessimistic.

Similarly, one should not be overly optimistic at present just because Q2 performance exceeded expectations. Looking at indicators reflecting customer payment rhythms, the current macro pressures objectively exist.

2. Changes in advertising strategies lead to greater expectation differences: However, this is not a completely brainless linear deduction by the market. Estimating based on the seasonal trend changes of "previous years" cannot reach the actual revenue level. The real reason lies in the change in advertisers' advertising strategies.

Facing consumers with tighter budgets, businesses are currently focusing more on coordinating with e-commerce festivals in their advertising timing, and choosing a more calm advertising approach during off-peak shopping seasons. For platforms like Focus Media, it is easier to show a seasonal characteristic of "busier peak seasons, quieter off-peak seasons".

May to June generally belongs to the off-peak season, but this year's 618 festival started earlier and ended later, extending the promotion period, making both May and June in the second quarter the peak marketing period for businesses. Since all the marketing efforts were focused on 618, March and April were relatively subdued compared to previous years. This subsequently led to Focus Media's Q1 and Q2 revenues showing a "counter-trend" change, with Q1 growth rate being too low and Q2 growth rate rebounding.

3. Accelerated expansion of lower-tier locations, with room for optimizing per capita costs: Since last year, Focus Media's media locations have been continuously expanding. In the first half of this year, the net addition of elevator LCD screens is still ongoing, with a focus on second and third-tier cities, which are relatively weak areas for Focus Media. Therefore, the expansion of lower-tier locations is a response to the trend of "consumption downgrading" (compared to the consumption decline in first-tier cities, the pressure in lower-tier cities is relatively smaller, and the decline is not as significant) Covering more sinking points is also the basis for subsequent cooperation between Fan Zhong and Meituan. Of course, first-tier cities have not completely shrunk, but are also slightly densifying in sync.

However, the rapid expansion of points has had some impact on the gross profit margin of elevator media starting from this year, with a 3% decrease in the gross profit margin of elevator media in the first half of the year. However, in terms of the cost of individual points, the average cost is still decreasing because the cost of newly added sinking points is relatively low. Considering the existence of a climbing period for new points, the subsequent benefits of individual points are expected to improve, restoring the overall gross profit margin of elevator media.

4. Mediocre profits not exceeding expectations? Spending more on marketing expenses: The impact of the gross profit margin of elevator media was offset by the repair of the cinema gross profit margin, but the operating profit of Fan Zhong's core business (excluding non-operating expenses, investment income, etc.) performed mediocrely, not exceeding expectations, due to high marketing expenses. To some extent, it can reflect that Fan Zhong is currently following the expansion of points, continuously exploring customers in the sinking market.

On the other hand, does the increase in marketing expenses also mean that the current environment is severe, with some loss of old customers and ineffective development of new customers, requiring more marketing investment? In the short term, the marketing expense ratio is still within the historical fluctuation range, so there is no need to panic for now. It is advisable to pay attention to the explanation during the conference call and continue to track the situation in the next quarter.

5. Cash flow rebound, confirming that Q1 was a random fluctuation: In the previous quarter, in addition to a significant miss in growth rate, while the profit increased by 10% year-on-year, the operating cash flow saw a 40% year-on-year decline, which the company explained was mainly due to the base effect. In 1Q23, there were many cash inflows that should have been received in 4Q22 due to the epidemic, which inflated the base. The operating cash flow in Q2 is returning to normal on a quarter-on-quarter basis, but compared to the low base of last year, it has significantly increased year-on-year, basically confirming the company's explanation of the random fluctuation.

6. Higher-than-expected dividends: Based on the performance in the first half of the year, the company expects to pay out dividends of 1.44 billion, with a dividend payout ratio of nearly 60%. Previously, the company guided that the dividend payout ratio for mid-2024 would not exceed 80%, so the actual dividend payout is just in line with expectations.

7. Comparison of key performance indicators with market expectations:

(Since fewer institutions publicly forecast Q2 performance separately, there is a certain deviation between BBG's consensus expectations and actual expectations. The following analysis combines the expectations of 2-3 top institutions to compare the actual performance of Q2 with market expectations.)

Dolphin's Viewpoint

Overall, the Q2 performance can be considered as an over-expected result under a collective pessimistic atmosphere. The significant deviation from expectations is caused by various reasons. Apart from the absolute advantage of Focus Media in offline ladder media, the different advertising strategies adopted by advertisers compared to previous years are also key reasons for the widening gap between market expectations and actual performance.

Although the increase in the annual advertising budget under this new strategy may not bring much incremental growth, it can temporarily alleviate the excessive panic caused by the unexpectedly slow Q1 to the market. In addition, the Olympics in July and August in the second half of the year can also slightly smooth out the fluctuations between the off-peak and peak seasons in Q3 and Q4, as well as offset some severe macroeconomic pressures.

Currently, Focus Media is in an expansion phase, and the potential impact on future profit margins should not be overlooked despite the revenue growth exceeding expectations. After all, most of the current funds are still more concerned about profit performance. However, judging from the marginal changes in gross profit margin in Q2, the rapid progress of ladder media is evident. The cost of this round of major expansion at lower-tier locations is relatively low, and the increased marketing expenses may mostly come from initial customer acquisition, which could still be digested or reduced in the future. Therefore, maintaining the profit level and the performance on the revenue side remain crucial.

Due to macroeconomic pressures in the second quarter, there was a slight slowdown in customer payment collection. However, with the global interest rate cut cycle approaching, at least in terms of expectations, the market's outlook for the macroeconomic environment in the second half of the year has slightly improved. The current valuation is in a more comfortable position compared to the awkward position in Q1, allowing for some adjustment room, and there may be expectations of a bottoming out rebound, thus slightly increasing the comfort level of holding stocks. However, the further consolidation of valuation support and upward momentum still depends on the actual implementation of policies.

Detailed Analysis of this Quarter's Financial Report

I. Q1's slow growth triggered linear extrapolation panic, but actual performance exceeded expectations

In the second quarter, Focus Media's revenue grew by 10%, significantly exceeding the market's expectation of 4%. The reason why the market expectation was so low was due to the low base advantage in Q1, with a year-on-year growth rate of only 6%. This made it difficult for the market to have normal or optimistic expectations for Q2, which had its own high base disadvantage and worse macro data.

In reality, if we look at the growth rate in Q2 alone, it basically follows the normal trend of a 10% price increase at the beginning of the year, which does not necessarily mean that the macro environment is much better than we imagine. As mentioned by Dolphin in the Q1 review, the current environmental trends are complex, with factors such as price increases, the Olympics, and the relatively favorable competition in e-commerce this year, so we should not be overly pessimistic. Similarly, we should not be overly optimistic about the current macro environment just because the Q2 performance exceeded expectations. From the indicators reflecting the pace of customer payments, the current macro pressure is objectively present.

From the industry performance perspective, overall advertising in the months of April to June faced significant pressure due to high base numbers and marginal weakening in social retailing. However, elevator media saw a growth rate of around 25%, performing well. Looking into the details, the growth trend of LCD is better, while elevator posters show significant monthly fluctuations.

Looking ahead to the third quarter, although July and August are traditionally off-season months, this year's Olympics are expected to offset the seasonal weakness. However, whether the advertising trend can be sustained after the Olympics will depend on the overall macroeconomic situation. Currently, the global interest rate cut cycle is approaching, which to some extent can increase the space for domestic policy relaxation, and there is a marginal change in market expectations towards a bottoming out.

Therefore, Dolphin Jun expects the growth rate in Q3 to continue to maintain around 10%, similar to the initial expectations at the beginning of the year, without adjusting it upwards due to the better-than-expected performance in Q2.

Moreover, during periods of severe macroeconomic conditions or operational issues, Dolphin Jun will also look at the actual situation and future trends through changes in downstream customer payments.

(1) Credit impairment: In the second quarter, there was a certain increase in credit asset impairment, which usually occurs when there is economic pressure.

(2) Accounts receivable turnover days: The turnover days in the second quarter remained basically stable on a month-on-month basis, but still showed some increase year-on-year, indicating that the current collection speed is slower than last year, reflecting some pressure indirectly.

II. Segment performance: In the first half of the year, the elevator media slowed down, and the theater picked up, but the marginal change varied in the opposite direction

In terms of the segment performance, in the first half of 2024, elevator media grew by 7.3% year-on-year, showing a significant slowdown compared to the second half of last year as the post-epidemic dividend fades; cinema advertising grew by 20.8% year-on-year under a low base, still recovering with the demand for movies. However, looking at the box office trend, the main contribution is in Q1, and Q2 performance will be relatively poor due to less high-quality supply.

In addition to the recovery in the film industry demand, Focus Media has also been expanding its cinema coverage in the past year, which has had some positive impact on revenue. In the first half of this year, they also signed contracts with 4 new cinemas, adding 8 cinemas compared to last year.

Looking ahead to the third quarter, although there are commercial hot films like "Claw Machine" with good feedback, the industry's box office performance is lower compared to the same period last year, so it is expected that there will still be some pressure on cinema advertising in Q3.

III. Consumption Slows Down, Internet Cools Down Again

In the first half of 2024, the largest client industry for Focus Media was still consumption, accounting for 64% again. The increase in proportion does not mean that consumption growth is good, as actual consumption growth is also slowing down. However, due to the poorer performance of industries such as the internet, entertainment, and local businesses, which directly declined year-on-year, the proportion of consumption was passively increased.

The cooling down of the internet and business services is concentrated in the e-commerce sector. Although there is continuous competition within the industry, because it is still in a cycle of cost reduction and efficiency improvement, in order to meet users' low-price mentality and increase cash voucher subsidies, there has naturally been a slowdown in some external spending.

The entertainment sector also saw a 12% year-on-year decline, which is related to the relatively limited game supply in the first half of the year, mainly concentrated in projects of several top factories. Top factories have many advertising channels, and offline media is not their main choice, so they cannot simultaneously benefit from the intensified competition among major factories. However, in the second half of the year, especially during the summer vacation period, the overall industry supply is expected to increase significantly, which may alleviate the decline in revenue in the entertainment sector.

In addition, the resurgent education industry is also in the process of rapid growth recovery, which is expected to drive the recovery of internet revenue. On the one hand, there is a certain increase in industry supply, and on the other hand, there has been a favorable shift in attitude towards the education industry in policies. In the recently issued "Opinions on Promoting the High-Quality Development of Service Consumption," it was mentioned that efforts should be made to further unleash the demand for service consumption, stimulate the vitality of improvement-oriented consumption in culture, entertainment, tourism, sports, education and training, residential services, etc.

In different regions, the significant difference in growth rates in the first half of the year is evident, with the growth rates in South China and Southwest China significantly higher than the performance in North China and Central China.

IV. How Does the Investment Period Affect Short-Term Profit Margins?

Since last year, Focus Media has been expanding its locations, especially in second and third-tier sinking markets. This is in line with the trend of consumption downgrading and sinking. The recent cooperation announcement with Meituan also reflects Focus Media's current sinking strategy The most significant impact during the investment period is usually on the profit margin. The gross profit margin may be affected by the temporary lack of signed advertising spaces in newly developed locations during the ramp-up period, while the investment period may lead to a high increase in marketing expenses due to the need for new customer acquisition.

In the case of Focus Media, there are some differences in details:

1) Limited impact on gross profit margin during ramp-up: The gross profit margin of ladder media in the first half of the year was 64.3%, a decrease of 3 percentage points compared to the second half of last year. However, Focus Media's gross profit margin reached 68% in the second quarter, not only showing a significant rebound from the first quarter but also maintaining a relatively high level of gross profit margin over the past three years.

Dolphin believes that on one hand, the rapid recovery of cinema advertising has driven the increase in the profit margin. On the other hand, the change from Q1 to Q2 also indicates that the ramp-up period for new expansion locations is not as slow. Moreover, the rental costs in the sinking market locations are much lower than in first-tier cities. The company expects to add 100,000 building TVs in the sinking market this year, with a total incremental cost of only tens of millions. This can also be seen in Dolphin's calculation of the average cost per single location, which shows that the average cost per single location in the first half of the year is 75,000, showing a decreasing trend year-on-year and quarter-on-quarter.

2) Short-term high growth in marketing expenses: The main change in operating expenses lies in marketing expenses. With the expansion of locations and the normalization of operations, customer activities will increase, including acquiring new customers and maintaining relationships with existing customers. Marketing expenses in the second quarter reached 620 million, continuing to grow by 15% year-on-year on a high base from last year.

Does the increase in marketing expenses also mean that the current environment is challenging, with some loss of existing customers and ineffective acquisition of new customers, requiring more marketing investment? In the short term, the marketing expense ratio is still within the historical fluctuation range, so there is no need to panic for now. The management of Focus Media has a certain forward-looking perspective on the actual industry situation. Based on previous years, high investment does not necessarily mean a pessimistic view of the current environment. It may be worth paying attention to the explanations in the upcoming conference call and continue to monitor the situation in the next quarter.

At the end of the second quarter, the operating profit of the core main business was 1.35 billion, a year-on-year increase of 3.2%, lower than the revenue growth rate. The net profit attributable to the mother reached 1.45 billion, a year-on-year increase of 12.6%, due to the increase in non-operating related income such as investment income. Although the growth in net profit attributable to the mother is good and exceeds expectations, Dolphin Jun mainly focuses on tracking the profitability of the core main business in terms of fundamentals. Compared with market expectations, the growth in profitability of the core main business in the second quarter was within expectations.