Focus Media: The Hot Expectations and Cold Reality of the "Advertising Empire"

Hello everyone, I am Dolphin Jun!

$Focus Media(002027.SZ) released its third-quarter report for 2024 on October 28th Beijing time. Although the policy shift at the end of September has driven expectations ahead, leading to a 37% rebound in the stock price. However, before policies promoting consumer livelihoods are actually implemented and effective, Dolphin Jun believes it is necessary to perceive the reality through financial reports and calculate the implied expectations of the current valuation.

Specifically:

1. Overall Impression: Expectations are good, but reality is challenging

Focus Media's revenue in the third quarter increased by 4.3%. Although there are certain differences in expectations among top institutions, overall it is still within the expected range (32-34 billion).

In the previous quarter, Dolphin Jun mentioned the strong seasonal effects brought about by changes in advertising placement strategies, which were also reflected in the third quarter. The third quarter is not a completely slow season, but rather a period of calm before prosperity, with September generally being a period for the release of new products in the 3C electronics and automotive sectors, as well as seasonal demand for clothing.

Additionally, this year is marked by the Olympics (beverages, clothing), short-term stimuli in certain consumer sectors such as gaming and entertainment (summer battles), and growth in home appliances (trade-ins). However, truth be told, due to overall macroeconomic pressures, the expectations of some institutions themselves are not particularly high.

The current valuation rebound clearly implies expectations of a warming consumer environment after policy stimuli. Dolphin Jun would like to remind that short-term pressures will not disappear so quickly. It is just that the fourth quarter is traditionally a peak season for Focus Media, and with the boost from events like Double 11, we expect the annual revenue to achieve a 7% growth rate, reaching a scale of 12.7 billion.

2. Slowdown in Customer Payment Rhythm

In the third quarter, on the one hand, credit impairment/asset impairment losses increased to 94 million compared to the previous quarter. In relation to total revenue, this proportion increased to 2.9%, a level that is only slightly lower than the 1Q22 affected by the epidemic over the past two years.

Furthermore, another indicator reflecting Focus Media's customer payment capability—accounts receivable turnover days—increased from 60 days in the second quarter to 68 days in the third quarter, higher than in 2023 and similar to the situation in the second half of 2022.

With a slight marginal deterioration in these two indicators, the difficulties in the macro environment are evident.

3. Profit Growth Depends Entirely on Non-Core Income

In the third quarter, net profit was 1.48 billion, with a year-on-year growth rate of 7.6%, slightly exceeding expectations, but mainly relying on investment income and other items unrelated to the core business.

Simply looking at the operating profit of the core business, it actually decreased by 9% year-on-year, slightly lower than market expectations. Similarly, comparing the net profit attributable to the parent company after deducting non-recurring items, the growth rate also slowed to 4.5% (the difference in effective tax rates leads to the difference between the growth rates of net profit after deducting non-recurring items and operating profit).

The decline in the core business's profit capability is mainly due to the rising credit impairment losses, followed by significantly higher marketing expenses than the revenue growth rate. Combined with a 17% increase in fixed assets compared to the end of the previous quarter, and a 35% year-on-year increase in cash employee expenses, it indicates that Focus Media is actively expanding media placements and expanding its sales team to attract more customers

4. Encouraging Aspect - Stable Increase in Gross Margin

Although the third-quarter report mainly reflects macro pressures, when it comes to its own operations, Focus Media's stable gross margin deserves special recognition.

Combining the distribution information disclosed in the semi-annual report and the gross margin situation of each business segment, Dolphin believes that despite revenue pressure and active expansion of locations, Focus Media's gross margin can still remain at a stable high level. This indicates that Focus Media has been continuously optimizing its locations, and the long-term effects are already evident.

At the same time, the newly added lower-tier locations have lower rental costs, and local businesses rely more on location-based advertising and traffic diversion. Therefore, the UE model for individual locations may not necessarily be lower than that of top-tier cities. However, during the rapid expansion of locations, the gross margin will inevitably be affected to some extent, which in turn means that there is still room for improvement in Focus Media's future gross margin.

5. Slight Decline in Cash Flow

The net cash flow from operating activities in the third quarter was 1.7 billion, an 8% year-on-year decrease. On one hand, although revenue is higher this year, the cash received from sales is lower than last year. On the other hand, in terms of cash outflows, especially employee-related expenses, there was a 35% increase in the third quarter compared to the same period last year.

6. Comparison of Key Performance Indicators with Market Expectations:

(Since few institutions publicly disclose quarterly expectations in reports, there is a certain deviation between the Bloomberg consensus expectations and actual expectations excerpted in the figure below. In the following analysis, Dolphin will focus on comparing the actual performance of Q3 with the expectations of 2-3 top institutions.)

Dolphin's Viewpoint

Focus Media's third-quarter report can be seen as a concrete reflection of the current challenging macro environment, while also demonstrating its efficient operations, indicating that the company still has the ability to improve its gross margin.

However, the performance of the third quarter is now in the past. Given the significant policy changes and the leading expectations, with the valuation having rebounded by nearly 40%, Dolphin believes that discussing the significance of the third-quarter performance at this point is not meaningful, and attention should be focused more on the future.

To be honest, so far, policies that can truly drive consumption have not yet emerged. And the current valuation, combined with the consensus expectations of institutions, has just returned to the historical median level of 18x P/E. However, considering next year's revenue and net profit expectations (around 14 billion and 6 billion respectively, with year-on-year growth rates of 9% and 12%) and the future three-year CAGR growth rate of around 10%, even with a dividend payout ratio of 4-5%, the 18x median valuation is relatively high from a neutral perspective. However, what is the expected growth rate for 2025 mentioned above?

In 2025, after going through the disturbance of the epidemic and returning to normal base, Dolphin believes that the consensus expectation of institutions is likely based on the company's usual 10% annual price increase to make predictions. However, in reality, if advertisers' consumption expectations do not reverse, leading to actual sales growth, it will be difficult to maintain the current advertisers' willingness to advertise (sales expense ratio).

So, is it possible for Focus Media to gain more share in the existing marketing budget?

Dolphin believes that this also depends on different environmental expectations. In a weak consumption environment/concept, it will continue to shrink the proportion of brand advertising that is difficult to quantitatively track ROI in actual merchant placements. At the same time, in a small amount of brand advertising budget, Focus Media also needs to compete with KOL marketing, short drama marketing, and online emerging platforms such as Xiaohongshu. Therefore, maintaining market share is also not easy.

However, the good news is that in traditional offline media, Focus Media is still the No.1 in the minds of advertisers. Therefore, the share that Focus Media is most likely to eat up still mainly comes from TV advertising, traditional outdoor advertising, and other competitors (trendy) in elevator media.

Overall, Focus Media is a more typical "cyclical stock". When the economy is doing well, advertisers have more money to invest in brand building, which in turn drives Focus Media's performance and valuation to soar. However, conversely, when the economy is under pressure, Focus Media will also be more affected than online channels. Although the current valuation has just been repaired to the historical median, it actually implies a certain level of optimism (emotional recovery in place). If there is no significant change in consumption expectations, this valuation median is by no means truly reasonable. Regardless of whether current policies do not directly stimulate consumption, even if they are really implemented, it will take some time to repeatedly verify from policy announcement to implementation and actual effectiveness.

Detailed interpretation of this quarter's financial report

I. Revenue: Short-term pressure is difficult to conceal

In the third quarter, Focus Media's revenue was 3.29 billion, a 4.3% increase, falling within the expected range of several top institutions (32-34 billion). The visible macro pressure in the second half of the year, so market expectations have also correspondingly lowered.

Last quarter, Dolphin mentioned the strong seasonal effects brought about by changes in advertisers' placement strategies, and the third quarter also reflected this phenomenon. The third quarter is not a complete off-season, but rather a period of calm before prosperity, with September generally being the new product release cycle for 3C electronics, automobiles, and the seasonal demand for clothing. Additionally, this year is also boosted by short-term stimuli in some consumption areas such as the Olympics (beverages, clothing), and short-term growth in some consumer sectors such as gaming and entertainment (summer battles), and home appliances (trade-in for new).

The current valuation rebound clearly implies expectations for the warming of the consumption environment after policy stimulus. Dolphin still wants to remind that short-term pressure will not disappear so quickly. It's just that the fourth quarter is Focus Media's traditional peak season, driven by e-commerce festivals, and the full-year revenue is still expected to achieve a 7% growth rate to reach a scale of 12.7 billion Industry Performance: Advertising Rebound in Q3, Led by Out-of-Home Media

In terms of industry performance, advertising rebounded before social retailing from July to September, mainly due to increased investment from businesses during the Olympics. Among different media channels, the growth performance of elevator media (LCD & posters) still leads the industry. Specifically, the apparel sector saw the most significant increase in advertising spending.

Cinema Advertising Revenue Likely to Decline in Q3

On the other hand, another source of advertising revenue for Focus Media, cinema advertising revenue, is expected to perform poorly in the third quarter. Although the third-quarter report did not disclose detailed business performance, this year's summer box office lacked high-quality films, with only "Claw Crane," "Silent Murder," and "Alien: Covenant" performing well at the box office. Unlike last summer, which had several blockbuster films with box office earnings exceeding 2 billion RMB.

Overall, movie box office revenue in the third quarter decreased by 43% compared to last year, with a corresponding 43% decrease in moviegoers. In this situation, it will be challenging for cinema advertising to perform well. This supply shortage issue is expected to persist into the fourth quarter:

During the National Day holiday, only one film, "Volunteers: Battle for Survival," exceeded 1 billion RMB in box office revenue. Although there are many upcoming films, there are few potential blockbusters, and their release dates are not during important holiday periods, making it difficult for them to achieve outstanding performance.

II. Revenue Outlook: Pressure Persists, Slowdown in Customer Payments

Looking ahead to the fourth quarter, festivals like Double 11 are expected to drive advertisers' strong seasonal effects in their advertising strategies. Coupled with some policy expectations, Dolphin Jun is not overly pessimistic about the fourth quarter.

However, it is also necessary to address the current short-term pressures, such as during periods of severe macroeconomic conditions or operational issues. Dolphin Jun will also assess the actual situation and future trends through changes in downstream customer payments:

(1) Credit Impairment: Credit asset impairment increased further in the third quarter, reflecting intensified macro pressures. It rose to 2.9% compared to total revenue, a level slightly lower than 1Q22, which was affected by the epidemic

(2) Accounts Receivable Turnover Days: The turnover days in the third quarter increased compared to the previous quarter, indicating that the current collection speed continues to slow down. This suggests that the current collection pressure is higher than in 2023, similar to the situation in the second half of 2022.

Overall, Dolphin expects a 5% revenue growth in the fourth quarter, reaching a scale of 3.4 billion RMB. This expectation implies a 3.9% quarter-on-quarter growth, indicating a stronger seasonal effect than in previous years. As a result, the annual revenue scale is 12.7 billion RMB, a year-on-year increase of 7%.

III. Net Profit Growth Depends on Investment Income, Stable Increase in Gross Margin is the Only Comfort

Since last year, Focus Media has been expanding its advertising locations, especially in second and third-tier sinking markets. This is consistent with the overall trend of consumption downgrading and sinking. The cooperation announced in the third quarter with Meituan also reflects Focus Media's current sinking strategy.

Generally, the biggest impact of the investment period is on profit margins. The gross margin may be affected by the temporary lack of signed advertising spaces in the new locations opened during the climbing period, while the investment period may lead to high growth in marketing expenses due to the need for new customer acquisition.

In the interpretation of last quarter's financial report, Dolphin mentioned the differences in Focus Media's performance, showing that the impact of the climbing period on gross margin is limited, but there is indeed a high growth in marketing expenses.

Referring to the third quarter report, it further strengthens the trend shown in the previous quarter:

1) Limited impact of climbing on gross margin: In the third quarter, Focus Media's overall gross margin was 68.2%, a slight increase of 0.2 percentage points compared to the previous quarter, remaining flat year-on-year. Considering that the utilization rate of cinema advertising in the third quarter should be very low, leading to a drag on the gross margin of cinema advertising, this in turn means that the gross margin of ladder media in the third quarter will actually be higher than the 64.3% in the first half of the year.

Dolphin believes that, combined with the distribution information of locations disclosed in the semi-annual report and the gross margin situation of each business segment, Focus Media's gross margin can still maintain a stable high level under the pressure of revenue but active expansion of locations. This indicates that the optimization actions Focus Media has been doing in locations have shown long-term effects.

At the same time, the newly added sinking point has lower rental costs (at the beginning of the year's conference call, the company expected to add 100,000 building TVs in the sinking market this year, with a total cost increase of only tens of millions. The average single point cost calculated based on the semi-annual report data also shows a trend of decreasing average cost as the company expands its sinking market. Local businesses also rely more on location-based advertising and traffic diversion, so the UE model for a single point may not necessarily be lower than that in high-tier cities.

Moreover, considering the rapid expansion of points, the gross profit margin will inevitably be affected to some extent. Therefore, conversely, it also means that Focus Media's future gross profit margin still has room for improvement.

2) Continued high growth in marketing expenses: The main change in operating expenses is in marketing expenses. With the expansion of points and the return to normal operations, customer activities will increase, including customer development and maintenance, corresponding to the expansion of the sales team.

Marketing expenses in the third quarter reached 630 million, a 12% year-on-year increase on a high base from last year. Fixed assets at the end of the third quarter increased by 17% compared to the previous quarter, reflecting Focus Media's simultaneous increase in investment in media equipment assets under active expansion of media points. In addition, cash outflows for employee expenses increased by 35% year-on-year, mainly due to the expansion of the sales team.

Although the gross profit margin is stable, the high growth in marketing expenses, coupled with a significant year-on-year increase in credit impairment losses, ultimately led to the core operating profit in the third quarter being only 1.31 billion, a decrease of 8.8% year-on-year under a 4% increase in revenue. However, net profit attributable to shareholders reached 1.48 billion, a 7.6% year-on-year increase, due to increased non-operating related income such as investment income and fair value changes

Dolphin "Focus Media" Historical Research:

Financial Report Season

August 9, 2024 Financial Report Review "Focus Media: Rising in Pessimism, Real Prosperity or False Rebound?"

April 30, 2024 Financial Report Review "Focus Media: Repairing or Hitting the Brakes? High Dividends are the Only Consolation"

October 19, 2023 Financial Report Review "Focus Media: Solid Repair of the "Ladder Grass""

August 10, 2023 Earnings Call "Focus Media Aims to be the Water Carrier of the AI Wave (1H23 Performance Call Summary)"

July 12, 2023 Earnings Forecast Review "Profit Surges Over 150%, Has Focus Media Turned the Corner?"

May 12, 2023 Earnings Call "Gradual Recovery Does Not Mean No Recovery, Optimistic Outlook for Q2 (Focus Media 2022 Performance Exchange Meeting Summary)"

April 29, 2023 "Focus Media: Disappointing Results? Wave Goodbye to the Past and Look to the Future"

October 31, 2022 "Focus Media: Walking Through the Darkest Times, But Can't Escape the Fate of the Cycle"

August 17, 2022 Earnings Call "Consumer Goods Resilient, Focus on Cost Control While Waiting for Real Recovery (Focus Media 1H22 Earnings Call Summary)"

August 16, 2022 Financial Report Review "Internet Collapse, Focus Media "Falls Apart""

July 14, 2022 Financial Report Review "Second-quarter profit plunges 70%, Focus Media's performance hits a 'pitfall'"

April 29, 2022 Earnings Call "March revenue drops 45%, Focus Media is struggling (conference call summary)"

April 29, 2022 Financial Report Review "Focus Media: 'Bloodbath' or a chance for a comeback?"

November 4, 2021 Financial Report Review "Starting with Focus Media: Lowering expectations for internet advertising is necessary"

August 26, 2021 Earnings Call "Cutting back, disappearing, standardizing - business in the second half of the year won't be easy (Focus Media summary)"

August 25, 2021 Financial Report Review "Focus Media: Looking good on the surface? Actually a 'thunderstorm'"

April 23, 2021 Earnings Call "Issuing an incomplete Focus Media conference call summary"

In-depth

December 21, 2023 "Is consumer spending warming up or cooling down? The unstoppable spring of advertising"

August 2, 2022 "Into the gold mine again? Is Focus Media 'gold' or 'a pit'?"

July 12, 2022 "Focus Media: The 'desperate fighter' who is changing fate against all odds"

Risk Disclosure and Disclaimer for this article: Dolphin Research Disclaimer and General Disclosure