Unlocking Growth in China's Lower-tier Cities: The Kuaishou advantage - Part 1

Executive summary

Executive summary:

The Chinese economy shows uneven growth; while certain sectors, particularly the real estate sector and those heavily dependent on it, face huge challenges, others, like dining out and traveling, have seen significant rebounds. This is evident in recent earnings reports from companies like Meituan (3690.HK), Trip.com $TCOM, and Tongcheng Travel (0780.HK), with GTV often up more than 100% year over year.

There is, however, a subtle shift occurring in the Chinese economy, breaking with previously observed patterns. Currently, growth is hard to come by in first-tier cities, often due to market saturation and post Covid-19 reduced spending power. In contrast, lower-tier cities offer new opportunities thanks to rising disposable incomes and increasing purchasing power. This shift has prompted companies such as Luckin Coffee (LKNCY), HEYTEA, Nayuki's Tea (2150.HK), Gu Ming, Antea and brands like Lululemon (LULU), along with Mixue Ice Cream, to target these cities for expansion.

Now, this is where Kuaishou enters the picture. Kuaishou, akin to TikTok in the West, competes with ByteDance's Douyin (the Chinese TikTok) in China. To clarify and avoid any confusion: Bytedance is the owner of both Douyin and its sister app, TikTok. What distinguishes Kuaishou from other social media platforms, including Bilibili ($BILI) and Xiaohongshu, is its strong presence in lower-tier cities.

Previously, Kuaishou's user base was considered a weakness. The argument was that brands and advertisers would prefer Douyin due to its higher presence in first-tier cities and more affluent user base.

Perception is gradually shifting. Kuaishou's user base is distinct from that of other social media platforms, making it the only viable solution for brands seeking to expand into lower-tier cities - and this is where the growth is. This unique positioning favors Kuaishou in attracting advertising revenue.

Kuaishou just became profitable. They have been slowly ramping up monetization efforts and have now reached an inflection point. They have successfully grown their user numbers and revenues, while operational expenses decreased by almost 20% since 2021. With operating leverage coming into play, I estimate conservatively that operating profits will increase by at least 150% in the next year, leading to a very attractive valuation.

They still have many more levers to pull; their ad load is lower compared to that of many of their Chinese and Western peers. Their e-commerce business has a low monetization rate of 1.2%, compared to the 3 to 8% rates of traditional Chinese e-commerce platforms. Moreover, they have just begun to venture into the local life services business. While local life services face fierce competition in tier 1 and 2 cities, they are much less developed in lower-tier cities, providing Kuaishou an opportunity to expand. Pinduoduo, another major player in lower-tier cities, has opted not to enter the local life services sector for the time being. This decision uniquely positions Kuaishou to seize a significant share of the market in these less developed areas. In their latest earnings report, they mentioned that a record number of merchants and advertisers are utilizing their platform. Additionally, other e-commerce players like Vipshop VIPS 0.00%↑ mentioned in their last call that they intend to expand the range of platforms they will use for advertising.

In summary, Kuaishou is one of China's leading social media platforms, holding a dominant position in lower-tier cities where significant growth is occurring. Now, with operational leverage coming into play, all of this is available at a very reasonable valuation.

In the following expanded post coming up next week, I will delve deeper into the details, discussing Kuaishou's competitive positioning and potential risks.

The article you can find now here.