In the last two months, the share price of SEEK (ASX:SEK) has fallen over 20 per cent. Surely this means that the shares are now very cheap? And what does the chart say about an entry point?
SEEK operates online job search sites in Australia, NZ (Seek ANZ, which is the major revenue and earnings driver), Asia (SEEK Asia), Brazil and Mexico, as well as investments in three businesses, the main one being a Chinese online job search site (Zhaopin). Other investments include online Higher Education courses and Early Stage Ventures.
Is the Core Domestic Business Slowing Down?
The domestic division (SEEK ANZ) is one of the higher-performing divisions. It has generated 16% revenue growth in FY18 from increased penetration of depth product and increased job ad volumes. It was the only division to have generated meaningful earnings growth. This is given the significant cost investment undertaken in other divisions.
Depth revenue for the SEEK ANZ division comprises only ~22% of divisional revenue. This is expected to accelerate in future years as the penetration rate of existing and new depth products increases. These include New Premium Ad and Premium Talent Search (PTS).
However, the key question is whether the contribution to revenue growth from depth products can be maintained/increased given that job ad volume growth appears to be slowing. This is according to the latest figures released for both the ANZ job ad series and the Seek New Jobs Index.
With the rate of domestic volume growth in FY19 likely to be lower, the SEEK ANZ division is reliant on a greater contribution from depth product penetration. To a lesser extent, it is also reliant on price increases. This is to ensure that the rate of revenue growth for the SEEK ANZ division does not step back materially from the 16% recorded in FY18. At this stage, market expectations are for slightly lower, but still strong, revenue growth in FY19. However, the declining volume picture presents downside risk to revenue growth expectations.
Zhaopin – Revenue Growth Evident But Competitive Pressure Remains
A key valuation driver for SEK remains its holding in Chinese job site Zhaopin. This accounted for ~35% of group revenue and 19% of revenue and EBITDA in FY18, respectively. Zhaopin’s revenues and EBITDA have accelerated after periods of reinvestment into the business, in particular over FY15-16.
Reflective of the highly competitive environment and need for significant cost investment, the EBITDA margin for Zhaopin has declined from 27% in FY15 to 18.0% in FY18. Meanwhile, the EBITDA margin for its main competitor, 51Job, has remained around the 30% mark over the same time period. These two factors are expected to continue to impact Zhaopin’s earnings in FY19.
Exposure To South American Economies Impacting Sentiment
SEK has an exposure to South American economies, via its Brasil Online and OCC (Mexico) businesses. In FY18, SEK wrote down the value of these two businesses by a total of $178m. A combination of local economic and competitive issues were blamed. While the impairment was non-cash in nature, the Company still retains an exposure. Whilst this exposure is only ~6% of group EBITDA, there is the risk of further impairments. This is in light of the highly subjective nature of book values for these two businesses, continuing challenging outlooks for both businesses, and the need for SEK to invest further in product and technology.
Fundamental View of SEEK
SEK is currently trading on a 1-year forward P/E multiple of ~28x, which we consider unappealing. In particular, the disparity in FY19 guidance for revenue growth (+16-20%) and EBITDA growth (5-8%) as a result of the need for ongoing cost investment is reflected in consensus EPS growth forecasts of 6% for FY19. The market is factoring in the expected benefit from cost investment to take effect in FY20, where consensus EPS growth forecasts are ~18%.
Secondly, in light of challenges in other area of the business, there is now greater dependency on the domestic business to generate group earnings growth. With this business itself facing declining domestic job ad volumes, we consider that there is downside risk to FY19 guidance.
Charting View of SEEK
SEK produced a bearish engulfing pattern on the weekly chart in early September (circled), and has been struggling ever since. There seemed to have been some recent support near $18 but that level failed to hold. At this rate, we expect the share price to keep falling to the next support level which is closer to $16.
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Michael Gable is managing director of Fairmont Equities.
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