iHuman Misses China Stock Rally As Investors Fret Over Stumbling Growth

Key Takeaways:

• iHuman’s revenue and profit both declined in the first quarter as it accelerated a global expansion plan to diversify beyond its softening home market in China
• The company’s gross margin and total users both improved, but the omission of its latest paid user count suggests that key metric continued to decline

By Doug Young

Sometimes what’s left unsaid speaks the loudest.

That could partly explain the 4.3% decline for shares of iHuman Inc. (NYSE:IH), a provider of educational products and services for young children, after it published its latest quarterly results last Friday. The report notably didn’t include the company’s latest number of paying users at the end of March, ending a previous practice of including that key metric.

Anyone reading between the lines would probably guess that omission was due to the fact that the number wasn’t too attractive and continued a recent trend of contraction that saw the figure fall by 17% in the fourth quarter to 1.45 million paid users.

The latest report also lacked any quantifiable information on the company’s recent drive to develop its business outside China, which it characterized as a strategic priority. Such a strategy looks prudent for Chinese companies from the educational sector due to the high risk from unpredictable regulatory oversight.

A sudden clampdown on China’s K-12 after-school tutoring sector two years ago wiped out an entire multibillion-dollar industry in an instant. iHuman wasn’t affected due to its focus on younger children and broader learning skills rather than specific courses like math and science. But there’s no guarantee that its area won’t become the future target of another crackdown aimed at lightening the burden of extra coursework on impressionable young minds.

iHuman made several references to the international expansion in its latest report, showing the importance it places on the initiative to diversify its business beyond China. But its failure to disclose any specifics suggests that part of the business has yet to produce any meaningful revenue, which may have disappointed investors.

While those unspoken elements probably worried investors, an acceleration in the company’s revenue declines was probably the biggest culprit behind the selloff of iHuman’s stock after the release of its latest report. iHuman said its revenue fell 11% to 235 million yuan ($32 million) in the first quarter from 265 million yuan a year earlier. The company’s revenue began to contract in last year’s fourth quarter, falling by a milder 4%, ending three years of steady growth since its IPO in 2020.

iHuman attributed the fourth-quarter revenue contraction to the pandemic, explaining that revenue for the fourth quarter of 2022 was exceptionally high and difficult to beat as many families used its services during lengthy periods of home confinement during China’s last-ditch effort to control the spread of Covid. It gave a similar explanation for the 11% decline in the first quarter, even though China had lifted its pandemic controls by the end of 2022 and people were no longer confined to their homes during the year-ago period in the first quarter of 2023.

While the pandemic provides a convenient excuse for its revenue contraction, an equally likely culprit is China’s slowing economy that is causing consumers to rein in their spending. Sellers of big-ticket items like cars and homes are feeling the effects of that caution most acutely. But providers of more discretionary items like the kinds of educational services sold by iHuman are also undoubtedly feeling the pinch.

Left behind

The selloff of iHuman’s shares after the report’s release wasn’t extremely large, and, in fact, the stock bounced back somewhat over the next two trading days. But more telling is a longer-term trend that’s seen iHuman’s shares get left behind from a broader rally for U.S.-listed Chinese shares earlier this year.

That rally lifted the iShares MSCI China ETF (NASDAQ:MCHI) more than 30% at one point from a low in February, and the index remains up by a much smaller 4.6% year-to-date. By comparison, iHuman’s shares have trended steadily downward since the start of the year and are now down 38% year-to-date.

The company has been profitable for the last two years and continued that trend in the first quarter. But the latest figure was down by more than half to 22.3 million yuan from 53.6 million yuan a year earlier, undoubtedly adding to investor concerns, as it attributed the decline to heavier spending on product development and its international expansion.

“While these increased investments may temporarily impact our short-term profitability, we believe they are crucial for reinforcing our industry leadership, sustaining our long-term growth, and creating long-term value for our shareholders,” CFO Viven Wang said in the earnings announcement.

Its odd mix of relatively solid profits and a sinking share price have left iHuman with a depressed price-to-earnings (P/E) ratio of just 4, and a similarly depressed price-to-sales (P/S) ratio of 0.72. The latter is actually ahead of the 0.33 P/S ratio for Mynd.ai (NYSE:MYND), though it trails well behind the 2.9 for Fenbi (2469.HK), both providers of educational products and services for young children. No matter how you slice it, investors are still relatively cautious on Chinese education stocks in general after many got burned from the earlier crackdown.

iHuman’s report wasn’t all downbeat and did include a few more positive metrics. While its paying users most likely fell during the quarter, the company’s monthly average users (MAUs) rose by a strong 25% to 26.4 million year-on-year. That marked an acceleration from the 14% gain for the metric in last year’s fourth quarter, and probably shows that parents still want this kind of service for their young children, even if they are less willing to pay for it.

The company’s gross margin also improved to 71.5% from 70.0% a year earlier and 71.2% in the previous quarter. Such margins are all quite high, and the improving trend shows iHuman is becoming more efficient in its core business of providing educational products and services for children. The main factor undermining its profit was a 17% increase in its operating expenses, led by a 36% rise in its sales and marketing activities as it rolled out more promotions and tried to build up its international business.

At the end of the day, iHuman is doing its best to navigate a tricky China market where the threat of crackdowns is always a possibility and consumers are increasingly cautious as the economy slows. There’s not much it can do about the regulatory risk. But it will need to show some more concrete progress in the international expansion, and also return to revenue and paid user growth before investors might consider returning to its stock.

This article is from an unpaid external contributor. It does not represent Benzinga's reporting and has not been edited for content or accuracy.