Intro & Thesis
I must admit that my timing isn’t always perfect when it comes to upgrades or downgrades, as they often don’t align with the subsequent movements in stock prices. My focus is primarily on financials – growth dynamics and margin conditions, as well as the overall state of the company’s industry. Assessing market sentiment, which often behaves unpredictably and independently, can be challenging.
After I upgraded GigaCloud Technology Inc. (NASDAQ:GCT) stock to “Buy” it started to collapse, having lost 45% of its value in the last quarter, while the S&P 500 index (SPY) (SP500) grew by about 1.6%:
Last time I expected that since the CEO addressed all the allegations against the firm, GCT should eventually rise driven by its great offering, robust balance sheet, and recent sales and earnings growth. Unfortunately for my bullish call, this has not happened yet.
After analyzing the company’s latest fundamentals today, I’ve come to the conclusion that the bloodbath GCT is still in should end at some point. The main reason for that lies in the possibility that the current expectations for margins and earnings growth are met. I don’t see any clear indication at this point as to why GCT’s business model would fail to meet current expectations – hence my “Buy” rating reiteration.
Why Do I Think So?
GigaCloud reported its fiscal Q2 FY2024 results in early August, showing total revenue of $310.9 million – more than double Q2 FY2023. Yes, GCT has started to lose operating leverage – Q2 gross profit increased by 89.1% YoY, but the growth rate was slower than the revenue increase. However, in my opinion, this is still very rapid growth and it’s unlikely that this has spooked investors and led to the massive sell-off following the results.
On the operational side, we saw that GigaCloud Marketplace has experienced significant growth, with its GMV rising by 80.7% YoY to ~$1.1 billion as of June 30, 2024. The GMV from third-party (3P) sellers also saw a substantial increase of 76.1% YoY, although its share of the total GMV slightly decreased to 52.1% from 53.4%. Anyway, the number of active 3P sellers grew by 39.8% (to 930), while active buyers surged by 66.8% YoY to 7,257. Additionally, the average spend per active buyer rose by 8.3% YoY, reaching $151,276. So again – absolutely nothing scary came from the unit economic metrics the firm reported. In my opinion, what we have on hand today only highlights the platform’s robust expansion and increasing engagement from both sellers and buyers.
Perhaps the market was unhappy with the fact that operating profit only increased by 17.3 year-on-year due to very rapid OPEX growth – this is really very “weak” compared to the revenue growth rate over this period. However, GCT was able to beat analysts’ estimates for non-GAAP EPS (GAAP EPS was in line with expectations) and also exceeded sales figures. Following the results, Wall Street analysts have significantly lowered their forecasts for Q3, but the projected EPS growth for several quarters ahead still remains very impressive.
The management said in the press release that they expect the firm’s total revenues to be between $266 and $282 million in Q3 FY2024, it’s $274 million in the mid-range, which is almost 54% higher than last year. The market prices are in a premium to the mid-range, expecting to see $280.7 million (closer to the higher value of the guidance range).
Key to GCT’s success in Q2 (and before the recent quarter, of course) has been the integration of Noble House and Wondersign, as well as the launch of its innovative Branding as a Service ((BaaS)) offering I discussed in my previous article. In Q2, Noble House-related SKUs contributed ~$57 million in GMV, and the management said during the earnings call they “plan to gradually open more SKUs to external buyers, aiming for profitability by the first half of 2025.” In other words, there is a high likelihood that the headwinds to earnings that existed earlier will soon disappear and management will have the opportunity to focus on correcting the net profit margin situation, which fell to 8.67% in Q2 FY2024 from 12% last year.
If we see no net margin improvement in Q3 FY2024, then GAAP EPS should increase by 1-2% according to my calculations if the current revenue consensus is correct. That said, without margin expansion, GCT will miss the EPS number in Q3 – management should do everything they can to get rid of the margin headwinds in Q3 as soon as possible to prevent this from happening. Judging by the confident guidance and comments in the earnings release, I believe they’re capable of doing this.
Earnings surprises are getting weaker quarter by quarter, but they’re still positive. Let’s assume that GCT reports in line with the current estimates (on average) for the next few quarters. In this case, without a recovery in the stock price, the company’s valuation should fall to 3.3x by the end of FY2026, with average annual EPS growth in the period 2024-2026 consistently above 27%.
GCT is certainly too cheap to ignore right now – at least that’s what the fundamentals say to me. As for sentiment, we still have a problem here. In my opinion, the current poor sentiment can only be remedied by an improvement in margins. I expect this to come from the integration of the company’s new assets over the next few quarters. This should undoubtedly be a strong bullish catalyst to bring GCT back to where it belongs (my estimate of fair value is 60-70% above current prices based on deviations from median values).
As the fundamentals do not strongly contradict my previous “Buy” thesis, I maintain my rating today but warn investors that GCT could miss Q3 earnings slightly if margins do not improve to at least Q2 FY2023 levels. You may find more on existing risks below.
Where Can I Be Wrong?
There are numerous investment risks that investors should consider before becoming active with GCT stock.
First off, the management itself acknowledges that there are now “industry-wide headwinds and soaring ocean freight costs” that challenge the whole business model of GCT and others. If these headwinds become more pronounced, my hopes for margin expansion may be overly optimistic.
Also, as I noted in my previous article, supply chain disruptions and regulatory changes could expose GigaCloud Technology to significant risk, as GCT’s model relies on partnerships with suppliers and resellers, making it highly vulnerable in tough economic times. In addition, GCT’s operations and profitability could be negatively impacted by changes in international trade regulations, tariffs, and policies, e.g. between China and the US.
In case my expectation of higher margins proves to be wrong, the current forecasts for EPS consensus might even turn out to be too optimistic rather than pessimistic, as I present them in my analysis today. In this case, my thoughts about GCT’s undervaluation will become irrelevant.
Furthermore, the stock has been in the consolidation phase for the last few weeks, and then it broke down the pattern and is moving down quite fast following that ‘accumulation’ phase. The theory of technical analysis tells me that the move may be too strong to just stop here, despite the stock’s cheapness. “Nothing good happens below the 200-day moving average,” some traders say, and since GCT broke through this important line, this was indeed the case. I’m hoping for an improvement in seasonality, but can’t be sure as there are too few observations so far.
The Bottom Line
Despite the continued downward momentum since I upgraded GCT stock to “Buy”, I believe that my decision was premature, but still – it wasn’t fundamentally wrong.
Yes, many investors have been concerned that GCT’s profit margins will continue to decline from the second quarter figure, and I can’t be confident that this will not be the case. However, management has made it clear what the current difficulties depend on and what investors should look out for in the coming quarters. First and foremost, I’d pay attention to how well GCT has managed to integrate the recently acquired assets into its ecosystem and how this has impacted operating costs. I’m also interested to see in Q3 how the company has managed the GMV expansion we have seen in recent quarters, and how well it’s monetizing now. Maintaining solid GMV and sales growth rates is also very important.
I think GCT is doing everything right – despite the obvious difficulties in the industry, the company is showing some of the most outstanding results that can be expected in the current circumstances. Management is trying to be transparent – I have written about this in more detail in a previous article.
I expect that once we see at least a slight improvement in margins, the cheapness of GCT will give the turnaround a boost.
Technically speaking, if you’re a cautious trader or investor, I’d better wait for a clearer reversal pattern to initiate a long position. Anyway, my rating stays unchanged today as I expect that as the sentiment improves, the bloodbath in GCT stock price will stop eventually.
Thank you for reading!
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