China growth stocks have been hammered over the past several months, and streaming giant iQiyi (NASDAQ:IQ) has been no exception. Once a high-flying company that was called the Netflix (NASDAQ:NFLX) of China and roared from $15 in March to $45 in June, IQ stock has gone in reverse over the past several months. Today, IQ stock trades just north of $20.
What happened? Trade tensions. Slowing China economic growth. A strong dollar. Bearish China stock market sentiment.
All of these things have weighed on IQ stock over the past several months. But, at the same time, IQ’s fundamentals remain strong. The company is still the leader in a secular growth market with tons of potential (revenues rose more than 50% last quarter, while subscribers rose by 75%), and in an economy that is still on fire (China GDP growth is still over 6%).
In other words, IQ stock still has its long-term growth drivers. Thus, is this recent selloff an opportunity to buy the dip?
Perhaps. But, investors need profitability to improve at IQ before this stock meaningfully rebounds. The one big difference between Netflix and iQiyi is profitability. Netflix has some. iQiyi has none. Until investors have reason to be constructive on iQiyi’s long-term profitability, IQ stock will remain depressed.
Long-Term Growth Fundamentals Remain Strong
Although everything from trade tensions to a strong dollar to slowing economic growth in China has scared investors away from China growth stocks, there is still a lot to like about the long-term iQiyi growth narrative.
Internet TV is the future. We already know this. Netflix has taken the archaic linear TV model, and improved it by making an affordable streaming service with quality content and unprecedented accessibility. Now, everyone is cutting the chord and going to streaming.
This is a global revolution, and most of the growth is happening outside of America. Last quarter, Netflix added just 1 million U.S. subscribers. Internationally, the streaming platform added nearly 6 million subscribers.
IQiyi is immersed in this red-hot international internet TV growth narrative. Moreover, they are insulated from global competition due to the China firewall which blocks Netflix in mainland China. Thus, so long as iQiyi can continue to dominate its China-based peers, the company has clear runway to dominate the China internet TV market.
That market is quite big. There are 4.2 billion internet users in the world. Nearly 800 million of them are from China alone. IQiyi has just 67 million subscribers. But, that that number grew by 75% year-over-year last quarter. The last time Netflix saw subscriber growth north of 5% was back in late 2010. Eight years later, Netflix is still growing subscribers at a 25% rate. Thus, small penetration with a big growth rate implies a long runway ahead for subscriber growth at iQiyi.
Overall, the long-term growth fundamentals for IQ stock remain strong. The internet TV trend remains a global phenomenon, iQiyi continues to dominate its China-based peers, and current sky-high growth rates imply we are still in the early innings of a robust growth narrative.
Profitability Needs to Improve to Support Valuation
Despite strong long-term growth fundamentals, IQ stock still doesn’t look that attractive on this dip for one big reason: profitability.
IQiyi ran an operating loss margin of 22% last quarter. Netflix’s operating margin was 12% last quarter. Moreover, iQiyi’s operating margin improved by just 200 basis points year-over-year. Netflix’s operating margin improved by 500 basis points year-over-year.
Thus, not only does Netflix have a far more attractive margin profile than iQiyi, but its margin profile is also improving at a far healthier rate.
Bulls will chalk this up to big investments amid iQiyi’s hyper-growth era. But, that excuse alone doesn’t make much sense. When Netflix was growing subs at a 50%-plus rate back in 2010, operating margins were still double-digit positive. Moreover, when Netflix was investing an arm and a leg in original content in 2015-2016, operating margins were still positive.
The big problem here is that the standard price for streaming service subscriptions globally is around $10 per month. But, in China, the standard price is around $3 per month. Thus, while Netflix is raking in around $10 in revenue per month from its subscribers, iQiyi brought home just $4.60 in revenue per month from each one of its subscribers last quarter, and that includes additional advertising revenue.
So long as unit revenue remains weak, profit margins will remain low. In order for IQ stock to rebound from here, you need to see profit margins meaningfully improve. In order for that to happen, you need unit revenues to go from under $5 to way above $5.
If that happens, IQ stock could soar. Until then, though, IQ stock will have trouble reversing from this recent selloff.
Bottom Line on IQ Stock
The long-term growth narrative supporting IQ stock is very promising. But, this stock won’t rebound in a meaningful way until profitability improves significantly. That isn’t happening right now, so IQ stock will have a tough time reversing course any time soon.
As of this writing, Luke Lango was long NFLX.
