Companies across the U.S. are currently reporting their financial results for the quarter ended June 30. It gives investors an important opportunity to peek behind the curtain of some of their stock holdings and see how they're navigating this challenging economic environment of high inflation and rising interest rates.
Few companies are as exposed to those headwinds as Sea Limited (SE 0.05%). Its business relies heavily on consumer spending, which is bad news during a time when household budgets are under pressure.
Investors once loved the company for its rapid revenue growth, but lately, it has sacrificed that attribute by slashing costs to focus on generating a profit instead. Its stock price has suffered over the past year, and it plunged even further following the release of its second-quarter financial results this month. It's now down 39% in August alone, but I'm going to tell you why that's a buying opportunity.
Sea Limited's Q2 results were mixed
There are three core parts to Sea Limited's business: e-commerce, digital entertainment (gaming), and digital payments. E-commerce is the largest segment by revenue, and it's also the main growth engine behind the entire company. Digital entertainment, however, has been a drag on Sea Limited's overall performance recently.
During the pandemic's height, there was a boom in online gaming as people were under quarantine and travel restrictions. Sea Limited owns Garena, a game development studio responsible for leading mobile titles like Free Fire. It has seen a big drop in usage and revenue in this segment since those restrictions ended, but some green shoots have just started to appear.
In Q2, the company's gaming business had 544 million quarterly active users. While that was down 12% year over year, it was up 11% from the previous quarter. Plus, while its revenue of $529 million was down 41% year over year, it was flat compared to Q1. Those results suggest a bottom might be forming in the gaming business, and a return to growth could be on the horizon.
Sea Limited's e-commerce business, on the other hand, remained strong in the latest quarter. The segment is led by the company's Shopee platform, which is a hybrid consumer-to-consumer and business-to-consumer marketplace.
Its revenue increased 20% year over year to $2.1 billion, but that was a big slowdown compared to the 51% growth it delivered at the same time last year. However, the platform did see an increase in both active buyers and their purchase frequency compared to Q1, which again suggests the worst part of 2023 might be over.
Here's why Sea Limited stock is down in August
Sea Limited was once known for its lightning-fast revenue growth, even if it came at the expense of profitability. But the company's priorities have shifted in the tough economic climate, and it's now focusing on running a leaner business that generates cash rather than burning it.
That means Sea Limited is spending less on customer acquisition. In Q2, it spent just $493 million on sales and marketing, which was half of what it spent in the same quarter last year. It also trimmed its research and development costs by 23% and its administrative costs by 19%.
Those cost cuts didn't happen overnight. The company has been on this journey for about a year now, and the good news is that it's working. As the chart below shows, Sea Limited swung its bottom-line result to a net income of $331 million in Q2, compared to a net loss of over $900 million in the year-ago quarter.
All that sounds pretty positive, right? Well, Sea Limited's newfound profitability has come at a price. Since the company has drastically slashed its marketing costs and focused less on customer acquisition, it has suffered an abrupt slowdown in overall revenue growth. As I mentioned earlier, its e-commerce revenue growth has slowed, and its digital entertainment revenue is shrinking.
The chart below shows that in Q2 2022, Sea Limited's total revenue grew 29% year over year. Now, that growth rate has slowed to a crawl, coming in at just 5%.
As a result, investors no longer perceive Sea Limited as a growth-at-all-costs company, which means they aren't willing to pay as high a price for its stock. Profitability is a highly attractive quality in any company, but in this case, the benefits are offset by the company's weak growth.
But here's why Sea Limited stock is a buy now
Not only is Sea Limited stock down 39% for the month of August, it's now down 88% from its all-time high, which was set during the tech frenzy of 2021. But I think the decline has gone too far, and here's why.
Sea Limited has now delivered $840 million in net income over the last three quarters, so it's entirely possible the next quarterly result will put the company over $1 billion in net income on a trailing 12-month basis. That would translate to about $1.67 in earnings per share, which would place Sea Limited stock at a price-to-earnings (P/E) ratio of 24.4.
That's a 19% discount to the Nasdaq-100 index, which trades at a P/E ratio of 30.2. It implies Sea Limited stock is much cheaper than its peers in the technology sector. Plus, the company's earnings could see a significant boost when the economy improves. As people begin spending more money, it will lead to faster growth in Sea Limited's revenue, and with its leaner cost structure, more of that revenue will flow to its bottom line as profit.
As a result, while Sea Limited stock looks cheap now, it might look even cheaper based on its earnings potential over the next 12 months and beyond. That spells opportunity for investors, especially while its stock is so heavily beaten down.
