Collaborations With Google Will Expand Global Reach In Online Marketing

Key Takeaways

• Integration of AI technologies enhances service quality and growth, while AI-driven subscriptions show strong potential for revenue expansion.
  
• Strategic operational adjustments and international partnerships aim to boost profitability and market reach, potentially increasing net margins and earnings.
  
• Decline in revenue and gross profit, coupled with execution risks in international expansion and AI integration, may impact future growth and profitability.

Catalysts

An internet technology company, provides online services in the fields of content, community, communication, and commerce in China.

• The integration of AI technologies, such as DeepSeek and Confucius models, is expected to significantly enhance the quality and efficiency of Youdao's educational services and online marketing. This innovation is anticipated to lead to revenue growth through improved customer satisfaction and retention.
  
• The notable growth in AI-driven subscription services, which saw a year-over-year increase of over 130%, indicates a strong potential for revenue expansion. As these services continue to evolve with advanced AI models, additional growth in this segment could bolster overall revenues.
  
• Youdao is focusing on enhancing profitability through strategic adjustments, such as streamlining operations and focusing on high-demand courses like Youdao Lingshi. By reducing less profitable areas, the company is likely to see improvements in net margins.
  
• The company's strengthening position in AI-enhanced smart devices, especially with products like the Youdao Dictionary Pen, supports long-term revenue growth. The ongoing success and innovation in this product line are likely to sustain and potentially increase earnings.
  
• Youdao's strategic partnerships and expansion into international markets, particularly in the online marketing segment, are expected to drive future revenue growth. Collaborations with companies like Google enable Youdao to expand its reach and effectiveness in global markets, potentially increasing earnings.

Youdao Future Earnings and Revenue Growth

Assumptions

• Analysts are assuming Youdao's revenue will grow by 11.6% annually over the next 3 years.
• Analysts assume that profit margins will increase from 1.5% today to 5.2% in 3 years time.
• Analysts expect earnings to reach CN¥404.9 million (and earnings per share of CN¥3.31) by about May 2028, up from CN¥82.2 million today. However, there is a considerable amount of disagreement amongst the analysts with the most bullish expecting CN¥509.5 million in earnings, and the most bearish expecting CN¥312.1 million.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 30.6x on those 2028 earnings, down from 92.0x today. This future PE is greater than the current PE for the US Consumer Services industry at 20.0x.
• Analysts expect the number of shares outstanding to grow by 1.06% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 7.79%, as per the Simply Wall St company report.

Youdao Future Earnings Per Share Growth

Risks

• The decline in net revenues, especially a 9.5% decrease compared to the previous year and a significant 21.2% drop in revenues from Learning Services, presents a risk to future revenue growth.
  
• The continued focus on selective customer acquisition, which involves prioritizing higher return engagements over broader customer acquisition, may lead to short-term revenue decline and impact future revenue growth.
  
• The overall decrease in gross profit by 13.3% year-over-year could negatively affect net margins and earnings, despite operating income margin improvements.
  
• Youdao's rapid expansion into international markets, including partnerships with global giants like TikTok and Google, involves substantial execution risks, which could impact revenue and earnings if these partnerships do not deliver expected results.
  
• The integration of large AI models and the development of new AI-driven services, while potentially promising, involve high future uncertainty and competition that could challenge sustained profitability and affect net margins.

Valuation

• The analysts have a consensus price target of $11.047 for Youdao based on their expectations of its future earnings growth, profit margins and other risk factors. However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of $14.56, and the most bearish reporting a price target of just $6.14.
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2028, revenues will be CN¥7.8 billion, earnings will come to CN¥404.9 million, and it would be trading on a PE ratio of 30.6x, assuming you use a discount rate of 7.8%.
• Given the current share price of $8.7, the analyst price target of $11.05 is 21.2% higher.
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.