iQIYI (NASDAQ:IQ), which provides video streaming services, saw its stock rally by more than 300% from its 52-week low of $1.65 back in October of 2022. However, despite some positive strides made by the company, such as inching closer toward profitability, several risks pose a threat to its investment case.
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Of particular concern are iQIYI’s narrow profit margins, sluggish growth trajectory, and the somewhat precarious state of its balance sheet. When you also factor in the company’s careless and lasting dilution, it becomes exceedingly difficult to rationalize the recent stock price, let alone anticipate it to be sustainable over time. Accordingly, I am bearish on the stock.
What Has Caused iQIYI’s Shares to Rally?
iQIYI’s impressive rally can be attributed to two primary factors, in my view — seemingly positive developments in the company’s operations combined with the fact that the stock was already trading at depressed valuation levels towards the end of the previous year.
Regarding the recent developments, iQIYI’s Q4 results showed some decent top and bottom-line progress that represented a significant improvement from the preceding quarters. Specifically, in Q4, total revenues landed at $1.1 billion, suggesting an increase of 3% compared to Q4-2021. While this was an uninspiring increase, the market apparently liked it, probably because this was the first quarter of positive revenue growth after four successive quarters of declining revenues on a year-over-year basis.
The company also recorded more than 10 million net subscriber additions in Q4, uplifting the average daily number of total subscribers to 111.6 million. For context, subs stood at 97.0 million in Q4-2021 and at 101.0 million in Q3-2022.
Another cheerful development was the company achieving improving margins and positive net income. In Q4, operating income came in at $113.6 million, with the operating income margin expanding to 10%. This compares to an operating loss of $153.0 million, or an operating margin of -13% in the prior-year period. As a result, the company was able to post its second-ever profitable quarter, bringing in $44.2 million in net income.
Given stabilizing revenues, a growing subscriber base, improving margins, and the fact that the stock’s price/sales valuation multiple had dipped as low as 0.4x toward the end of 2022, you can clearly see why the stock was poised to undergo a massive valuation multiple expansion following the tiniest of upbeat progress.
Core Issues Have Not Gone Away
Despite the recent positive developments just discussed, the core issues that have been hindering iQIYI’s prospects remain unresolved. While the recent advancements appear promising, they are merely a small step forward in the context of the company’s overall trend of continuous erosion.
Alarming Revenue Growth Trajectory
To be more specific, even though iQIYI reported positive revenue in Q4, for the full fiscal year, revenues actually declined by 5.1%, marking the worst year for the company’s top-line growth. Additionally, iQIYI’s trajectory of worsening revenues was further bolstered — just take a look at its course in recent years:
- 2016 revenue growth: 111.3%
- 2017 revenue growth: 53.7%
- 2018 revenue growth: 43.8%
- 2019 revenue growth: 16.0%
- 2020 revenue growth: 2.5%
- 2021 revenue growth: 2.9%
- 2022 revenue growth: -5.1%
Profitability & Margins
Moreover, even though iQIYI’s margins and profitability have indeed been improving, including the company recording its first ever two profitable quarters in Fiscal 2022, it still lost money during the year. Net losses in Fiscal 2022 came in at $17.4 million, with iQIYI having yet to achieve a profitable fiscal year.
At the same time, even with margins improving, they still remain razor-thin and will be utterly unable to drive meaningful earnings growth in the coming years. The mere 4% net income margin recorded in Q4 was primarily achieved through cost-cutting.
Given this is an SVOD platform that requires continuous capital expenditures to keep subscribers engaged with fresh content — like Netflix (NASDAQ:NFLX) — the company can cut expenses only so much. Boasting more than 110 million subscribers, any economies of scale that could have been achieved should have already materialized by now. Thus, it appears the company has little to no additional catalysts that can contribute to a further margin expansion.
Balance Sheet Health & Dilution
My last major concerns regarding iQIYI are its heavily indebted balance sheet and endless dilution. The company’s total debt position stands at $3.2 billion, and it has grown substantially over the years. With the company barely capable of recording positive net margins, one can only wonder how management will be able to pay it down (or refinance it at decent rates) in the coming years.
In a rising-rates environment, any tiny bit of profitability the company has been able to achieve could be evaporated instantly by higher interest expenses once iQIYI refinances its debt at higher rates.
In the meantime, since iQIYI has yet to generate a positive free cash flow, it continues to issue shares as a source of funding. The company’s share count has risen 33.7% since the stock’s IPO, significantly diluting shareholders who have yet to be compensated via meaningful value creation.
Is IQ Stock a Buy, According to Analysts?
Turning to Wall Street, iQIYI has a Strong Buy consensus rating based on six Buys and two Holds assigned in the past three months. At $8.93, the average IQ stock price target suggests 25.95% upside potential.
The Takeaway
The astronomical surge of iQIYI’s shares by over 300% in recent months is undoubtedly remarkable. Nevertheless, this surge cannot rectify the fundamental challenges that are impeding the company’s progress. Despite some encouraging signs in Q4, they are relatively insignificant in the grand scheme of things. The company’s revenue growth is still slowing down, its profit margins are thin, and its balance sheet is weighed down by debt and dilution. Thus, I don’t believe the recent rally will be long-lived.
