So-Young International Stock: Tough Times (NASDAQ:SY)

Elevator Pitch

My initial investment rating for So-Young International Inc.’s (NASDAQ:NASDAQ:SY) shares is a Hold.

It has been tough times for So-Young International in 2022 year-to-date, as seen with its topline decline for Q1 2022 and Q2 2022. There could be a short-term catalyst for SY in the form of better-than-expected results relating to its new product, So-Young Select. But the intermediate-term outlook for SY is still unfavorable, considering factors like China’s macroeconomic environment, and new regulations which have a negative impact on the Chinese medical aesthetics market. Therefore, I think that a Hold (rather than Buy or Sell) rating is justified for So-Young International’s stock.

Challenging Operating Environment For The Chinese Medical Aesthetics Market

So-Young International refers to itself as the operator of “the largest and most vibrant social community in China for consumers, professionals and service providers in the medical aesthetics industry” in its media releases.

SY generated 77% of its fiscal 2021 revenue from information services, or fees collected from service providers in exchange for sharing information about their medical aesthetics services in the community, according to its most recent 20-F filing. Reservations services (revenue relating to sales leads for service providers), and the sales of equipment & related maintenance services contributed the remaining 16% and 7% of its topline, respectively last year.

Both So-Young International and the medical aesthetics industry in China have faced multiple headwinds in recent times.

Firstly, China’s economy is expected to slow in the foreseeable future, and this is evidenced by economists revising their 2022 and 2023 GDP growth estimates downwards as highlighted in a recent August 29, 2022 Bloomberg article. Given that medical aesthetics procedures are largely discretionary in nature, it is no surprise that short-term demand for medical aesthetics in China has weakened, and this also translates into lower revenue for So-Young International.

Secondly, China appears to be persisting with the country’s COVID-zero stance as it stands now. This implies that lockdowns and tighter pandemic restrictions will be seen in different parts of Mainland China from time to time when there is a spike in COVID-19 cases in specific areas. This is very disruptive for the Chinese medical aesthetics industry, where customers might be deterred or restricted from going outdoors to utilize related services. Similarly, users will be less keen to visit So-Young International’s online platform and community to be updated on related developments in the medical aesthetics industry in China.

Thirdly, the Mainland Chinese aesthetics market is facing significant regulatory pressures. A Reuters news article published a year ago on August 27, 2021 mentioned that “draft guidelines on regulation of the (Chinese) medical aesthetics sector’s advertising” were issued with the aim to “crack down on ads that create anxiety over people’s looks.” Consulting firm Kline also noted in a May 27, 2022 write-up that Chinese regulatory authorities “issued four new regulations to rule out counterfeit products and unqualified institutions from the professional skin care market.” While these new regulations were probably put in place with good intentions having the interests of Chinese consumers in mind, they will inevitably have a dampening effect on the growth of the medical aesthetics market in Mainland China.

The tough operating conditions for So-Young International are reflected in the company’s key recent financial and operating metrics as detailed in the subsequent section of the article.

Key Financial And Operating Metrics For SY

SY’s revenue fell by -31.6% YoY from RMB452 million in the second quarter of 2021 to RMB309 million in the most recent quarter, as indicated in its Q2 2022 earnings press release. This marks the second consecutive quarter of topline contraction for So-Young International; SY’s sales also declined by -16.5% YoY in the first quarter of this year. Prior to Q1 2022, So-Young International had delivered positive topline expansion in the seven quarters between Q2 2022 and Q4 2021.

Notably, So-Young International’s Q2 2022 revenue had benefited from the incremental sales of around RMB59 million contributed by its new sales of equipment & related maintenance services business segment, which was created with the acquisition of Wuhan Miracle Laser System in the prior year. Excluding the impact of the M&A transaction concluded in 2021, SY’s adjusted organic revenue decline for the second quarter of the current year would have been even worse at -44.7% YoY (versus headline topline contraction of -31.6%).

Also, SY reversed from positive non-GAAP adjusted earnings of +RMB73.7 million in Q2 2021 to record a non-GAAP adjusted net loss of -RMB22.7 million for Q2 2022. One key contributing factor is the negative effects of operating leverage, which resulted in a relatively larger drop in So-Young International’s bottom line as compared to its topline contraction. Another key contributing factor is an unfavorable revenue mix, as SY’s gross profit declined by -20.8 percentage points YoY to 66.2% in Q2 2022. The new sales of equipment & related maintenance services business segment or Wuhan Miracle Laser System boasted relatively inferior profitability as compared to the company’s information services and reservation services business segments.

The key operating metrics for So-Young International in the recent quarter were also disappointing.

Monthly active users for SY decreased by-20.5% QoQ and -65.0% YoY to 3.5 million for Q2 2022. The total value of transactions executed in So-Young International’s community and the number of paying users for SY shrunk by -35.8% YoY and -47.1% YoY to RMB353 million and 129,500, respectively in the recent quarter.

Spotlight On So-Young’s New Product

Moving beyond the short-term headwinds for SY, the spotlight is on So-Young’s new product launch.

In its second-quarter results media release, So-Young International noted that it introduced a new product into the market referred to as “So-Young Select” with the purpose of assisting “medical service providers improve operating efficiency” by achieving “lower cost and high efficiencies to acquire customers.” SY added at its Q2 2022 results briefing that So-Young Select was first launched in six Chinese cities in July 2022 with a selected number of “high-quality and high standard service providers”, and the initial results suggest that the new product had improved the specific “service providers’ user conversion rate.”

It is understandable that SY hasn’t revealed too much details about the workings of the new So-Young Select for competitive reasons. But it is noteworthy that the new So-Young Select product roll-out is only at a very early stage, with only certain cities in China and some service providers being chosen for the initial launch.

If So-Young Select continues to deliver positive results when it is expanded to other Chinese cities and service providers going forward, this could translate into upside surprises for SY’s financial performance in the second half of this year. The market’s expectations for So-Young International are low, with S&P Capital IQ’s consensus numbers pointing to the company’s registering a YoY revenue contraction of -29% for both Q3 2022 and Q4 2022.

Closing Thoughts

So-Young International’s shares are deserving of a Hold rating at best. On one hand, I am encouraged by the initial success of the company’s new product, So-Young Select, and the potential boost to SY’s second-half results. On the other hand, the key headwinds for SY such as economic weakness, COVID-zero policy and regulatory challenges aren’t likely to disappear anytime soon.