Futu Research | Oriental Selection (1797.HK) Earnings Report Analysis: Transformation Challenges or Entering a Competitive Market?

On January 24, 2024, Oriental Selection (1797.HK) released its interim financial report for the fiscal year 2024. Following the release, on January 25, 2024, Oriental Selection's share price closed at HK$24.2, down 8.33%. How should this earnings report be interpreted?

Data source: Futubull

The analysis is approached from three dimensions: Investment return = EPS growth × Valuation change + Shareholder returns.

However, from a business perspective, Oriental Selection's performance hinges on its livestream e-commerce and self-operated e-commerce operations.

First, let's analyze the business performance reflected in this financial report.

First, we will break down the business situation:

(1) Spin-off of the university business. Oriental Selection's university education business is already planned to be spun off from Oriental Selection.In December 2023, the company announced the sale of its education business to New Oriental Group for RMB 1.5 billion, with the closing expected on March 1, 2024.）；

(2) Live-streaming services are highly significant. Specifically, conducting live-streamed sales on platforms such as Douyin and Taobao serves as the primary revenue source, with income mainly derived from commissions on sales generated through the Douyin platform. The commission rate typically ranges from 10% to 30% of sales, but the business has relatively low technological barriers and is highly susceptible to substitution.

(3) Self-operated business represents the direction of future development. At present, Dongfang Zhenxuan is actively building its own brand and mobile app, and has launched numerous promotional offers and subsidies in the early stages. To date, the platform has approximately 200,000 registered users, a relatively small proportion; for now, Dongfang Zhenxuan still primarily generates revenue through live-streamed e-commerce on the Douyin platform.

Overall, Dongfang Zhenxuan's business structure consists of livestream e-commerce and self-operated sales.At present, the company's primary strategic objective is to gradually shift from relying on the Douyin platform for sales promotion to building a business centered on developing its own private-label brands. To assess this shift, we need to examine the performance reported in the latest financial results.。

Data source: Dongfang Zhenxuan

How does Dongfang Zhenxuan generate its revenue?

Having clarified Oriental Selection's business model, let's now examine its core operating revenue.

（1）Dongfang Zhenxuan's primary revenue comes from commissions on livestream sales via Douyin.During the reporting period, Dongfang Zhenxuan's GMV reached RMB 5.7 billion, with the vast majority coming from Douyin. The total number of paid orders for third-party and self-operated products on Douyin during the period was 59.6 million. However, it is evident that Dongfang Zhenxuan currently faces a clear ceiling on Douyin, making substantial short-term growth challenging.

(2) The incremental GMV is primarily driven by newly expanded platforms, such as the launch of the company's proprietary app in July 2023 and its entry into Taobao Live in late August, which have both broadened user reach and further diversified the product assortment. In addition, the proprietary app introduced a paid membership program in October, which currently boasts nearly 200,000 members with an average monthly spend of RMB 800; however, overall revenue from the proprietary channel remains relatively low.

In other words, Oriental Selection currently relies on commissions earned from livestream sales on Douyin as its core revenue stream, while simultaneously investing heavily in developing its own proprietary app. How effective has this strategy been?

(1) Revenue increased from RMB 2.08 billion in the same period last year to RMB 2.8 billion, a growth of 34.4%;

(2) Among them, e-commerce (including self-operated businesses) grew from RMB 1.77 billion to RMB 2.41 billion, an increase of 36.6%;

(3) University education increased from RMB 295 million to RMB 365 million, representing a growth of 23.9%;

It's clear that current revenue growth is driven by the expansion of our e-commerce business; however, building out our direct-sales operations requires significant capital investment, which leads us to the next step.

Figure: Main Business Operations of Dongfang Zhenxuan (in RMB, in ten thousand yuan)

Data source: WIND

3. How are funds (costs) utilized?

During the reporting period:The company's launch of its proprietary mobile app and entry into Taobao's livestreaming channel have led to higher inventory and transportation costs for its own-brand products, significantly driving up sales expenses. Additionally, to expand the scale of its self-operated product selection and livestreaming business, the company has hired more staff (increasing administrative expenses), invested more in sales and marketing, and launched the "Dongfang Zhenxuan" app, all of which have resulted in a substantial increase in cost expenditures (R&D expenses).

In summary, the data situation is as follows:

(1) Marketing expenses surged from RMB 227 million to RMB 559 million, primarily due to expenditures on self-operated products and livestream hosts;

(2) At the same time, administrative expenses increased from RMB 62.3 million to RMB 142 million, reflecting a significant overall rise in costs, mainly attributable to equity-based incentives and recruitment expenditures.

At this juncture, taking the above factors into account, we observe that Dongfang Zhenxuan has incurred substantial cost increases, yet its revenue growth has been relatively modest. Moreover, given the intense industry competition, it is difficult to reduce spending on self-operated traffic acquisition, incentives for livestream hosts, and employee compensation. From a cost perspective, such rapid cost expansion is more likely driven by a deteriorating competitive landscape, which has prompted increased investment in traffic acquisition and talent recruitment. The likelihood of a future downturn remains uncertain, so we must assess the potential returns on this investment.

Figure: Cost Breakdown for Dongfang Zhenxuan (in RMB, in ten thousand yuan)

Data source: WIND

II. Let's Calculate the Investment Returns

When evaluating investment returns, consider three dimensions: Investment Return = EPS Growth × Valuation Change + Shareholder Returns.

1. EPS (Earnings Per Share):

Earnings per share (EPS) measures how much profit a company generates for each share of stock; it is an indicator of a company's profitability. The higher the EPS, the stronger the company's ability to generate returns for its shareholders. So, what about the profitability of Oriental Selection?

According to the Oriental Selection 2024 Fiscal Year Interim Results Report:

Diluted EPS was RMB0.25, compared with RMB0.6 in the same period of November 2022, representing a year-on-year decline of 75%.

Based on the foregoing, Oriental Selection's EPS has declined sharply, clearly illustrating a pattern of revenue growth without corresponding profit growth. Moreover, will profit margins continue to decline going forward? Given the intense level of industry competition, it remains doubtful whether margins will improve. Given the uncertainty surrounding sustained EPS growth, it follows that valuation pressures are likely to be substantial as well.

2. Valuation: (current valuation level; will it rise or fall in the future?)

From a valuation perspective, there is considerable uncertainty surrounding Oriental Selection's future valuation.Although the company's revenue grew rapidly year on year this quarter, the main reason for the decline in EPS is the increase in sales and administrative expenses resulting from the promotion of its self-operated business and the recruitment of more livestreamers for promotion. Promoting the self-operated app and cultivating user stickiness require Oriental Selection to invest substantial sales expenses over a relatively long period. Moreover, given the intense market competition—with players such as JD.com's self-operated business and NetEase Yanxuan already present in the market—the effectiveness of the company's self-operated business promotion remains highly uncertain.Therefore, unless the expansion of its proprietary business exceeds expectations, the company is expected to continue to face market skepticism about its profit margins in 2024 and for the foreseeable future.Therefore, the company's future valuation will depend on further monitoring of the rollout progress of its proprietary app.

3. Shareholder Returns (Dividends and Share Repurchases/Reductions):

According to the company's historical data, shareholder returns have been very modest, and the company is currently in an expansion phase, making it difficult to assess its prospects at this time.

III. Summary

Overall, with live streaming as its core business model and its direct-sales operations facing intense competitive pressure, the company must continue to invest heavily while its revenue and profit growth remain uncertain. Given its currently high valuation and the lack of shareholder returns, investing in Oriental Selection poses significant challenges for existing shareholders and investors. If profit margins fail to improve, and considering the generally low valuations across the Hong Kong stock market, Oriental Selection is likely to remain trading at a discount relative to its intrinsic value.

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