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QIHU rated BUY at Chinavestor

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QIHU_2012Q1_tumb September 2012 (Chinavestor) For disclaimer and report with full financial data, download the pdf version: CV_QIHU_2012_Q1.pdf

We suggest our Buy rating on Qihoo 360 Technology (NYSE:QIHU). QIHU is a leading anti-virus service provider in China. Due to the large internet flow generated by its free anti-virus products, QIHU is leveraging its user base to increase the revenue and profit in the fields, such as online advertising and internet value-added services. However, its potential ability of better utilizing its online resources and customer base need to be confirmed in the future and the mobile internet industry is a good chance yet potential threat to its future business.

 

Strong revenue, gross profit margin, and earnings growth

Due to the good performance of QIHU’s segments, such as online advertising and internet valued-added services, QIHU’s increase rate in revenue and profit has outperformed other competitors in China, such as  Sohu.com Inc. (NASDAQ:SOHU), NetEase Inc. (NASDAQ:NTES), Tencent Inc. (HKG:0700), and SINA Inc. (NASDAQ:SINA).

Good financial position

Quarterly and annual data indicate QIHU’s strong financial position, in terms of liquidity ratios and solvency ratios.

Improved cash flow conditions

QIHU’s cash from operations (CFO) has continuously increased during past years, which is an indication of its success of major business development. The free cash flow generated by QIHU’s fundamental business has also increased in both quarter-to-quarter and year-to-year basis.

Business outlook for QIHU

The future possible expansions of QIHU’s business are in searching and mobile internet industry. Cautions need to be paid to follow its future business development plan in these fields, as they could be able to generate large scale revenue and profit for Qihoo 360 Technology (NYSE:QIHU).

Business Overview

Qihoo 360 Technology (NYSE:QIHU) is the No. 2 Internet company in China as measured by monthly active user base as of December 2011, according to iResearch. At the end of 2012, Qihoo 360 Technology (NYSE:QIHU) has 402 million monthly active users, which represents 93.8% of total number of Chinese internet users. The core internet and mobile security products provided by QIHU are: 360 Safe Guard and 360 Anti-virus for PC users; 360 Mobile Safe for smartphone users. According to iResearch, the monthly active users as of December 2011 for 360 Safe Guard and 360 Anti-virus are 363 million and 352 million, respectively, which are ranked No.1 and No.2 internet security products in China. With over 50 million active users in China, 360 Mobile Safe has obtained approximately 60% of mobile security market as of March 2012. QIHU’s revenue increased from $32.3 million in 2009 to $57.7 million in 2010 and $167.9 million in 2011. Its net income increased from $4.2 million in 2009 to $8.5 million in 2010 and $14.5 million in 2011.

 

Suggest Buy Rating

1. Strong revenue, gross profit margin, and earnings growth

  • Quarterly Income Statement Analysis

As to the quarter to quarter result comparison, the revenue increase shows a declined rate, from 57% increase of revenue in Q2 of 2011 to 11.17% increase of revenue in Q1 of 2012. Despite for the Q2 of 2011 when the net income turned from -21.45 to 11.11 million, the net income during the other past 4 quarters didn’t show much increase and stays in the range of 10.90 to 15.03 million.

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However, the revenue and gross profit show strong growth as compared to the same period last year. The revenue in Q1 2012 increased by 209% from Q1 2011 to USD 69.28 millions, gross profit increased by 206% from a quarter a year ago to USD 61.66 millions, and net income is reverted from negative to USD 14.07 millions as the first quarter of 2012.

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The gross profit margins for the quarter data of Qihoo 360 Technology (NYSE:QIHU) are fairly stable, which are within the range of 88% to 89%. As for the net profit margin, it increased dramatically at Q2 2011, since the net income turned from negative to positive. Afterward, the profit margins decrease at a very slow rate till Q1 2012.

 

  • Annual Income Statement Analysis

As to the year to year operation data, QIHU has shown good improvement in its operation and better profit margins as compared to its competitors.

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The annual data shows that revenue growths are increasing fast from 2008 to 2011. Revenues increased by 91%, 79%, and 191% in 2009, 2010, and 2011, and the values of revenue are USD 32.30, 57.66, and 167.85 million in these three years, respectively. Compared to 2008, the net income in 2009 turned from negative to positive of 4.19 million, and the net income increased consecutively about 103% each year for 2010 and 2011.

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The annual data above shows that the gross profit margins from 2008 to 2011 have increased, while at a decreasing rate. The gross profit margins are 51%, 74%, 88%, and 89% in year 2008, 2009, 2010, and 2011, respectively. The net profit margins also increased from 2008 to 2010, however, the profit margin declined in 2011 from 15% to 10%.

 

  • Annual Gross Profit Margin Comparison

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Through the comparison of gross profit margins between QIHU and other 4 companies who share part of the same business in Chinese internet industry, SINA (NASDAQ:SINA), SOHU (NASDAQ:SOHU), Netease (NASDAQ:NTES), and Tencent (HKG:0700), it is found that the gross profit margin has increased fastest for Qihoo 360 Technology (NYSE:QIHU) in the past years. In the most recent fiscal year 2011, the gross profit margin for QIHU is 89%, which is the highest, while it is 72% for SOHU, 67% for NTES, 65% for Tencent, and 55% for SINA.

If QIHU could better seize the opportunity in the online advertising and internet value adding services industries in China by continuing leveraging its large user base, it is possible that it could maintain this high gross profit margin in the next coming years with fast revenue growth at the same time.

 

2. Good Financial Position

  • Quarterly Comparison of Financial Strength Ratios

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The comparison of quarterly data for current and quick ratios illustrates QIHU’s good liquidity and strong ability to meet its short term obligations. The current and quick ratios for Qihoo 360 Technology (NYSE:QIHU) increased dramatically during Q2 2011, which is due to QIHU’s IPO in that quarter, and its current and quick ratios declined since Q2 2011, while still being highest among the competitors.

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The comparison of quarterly data for debt to asset and debt to equity shows that, after Q1 2011, Qihoo 360 Technology (NYSE:QIHU) has both lowest debt to asset and debt to equity ratios among these competitors. This means that it is operating at relatively low leverage and is able to increase return on asset/equity (ROA and ROE), if it wants to leverage its business by sizing up more debt in the future.

 

  • Annual Comparison of Financial Strength Ratios

The comparison of annual data for current and quick ratios illustrates QIHU’s good liquidity and strong ability to meet its short term obligations. The current and quick ratios for Qihoo 360 Technology (NYSE:QIHU) increased dramatically during in year 2011 and both become highest among major competitors

The comparison of annual data for debt to asset and debt to equity shows that QIHU has steadily declined its leverage year by year. The leverage has become lowest for QIHU among its major competitors since 2011.

To sum up, QIHU has demonstrated good financial health through these years’ operation, especially when compared to its major competitors in Chinese internet industry.

 

3. Improved Cash Flow Conditions

  • Annual Cash Flow Analysis

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From the cash flows of Qihoo 360 Technology (NYSE:QIHU) shown above, it is found that all three cash flows (cash from operations, CFO, cash from investing activities, CFI, and cash from financing activities, CFF) increased significantly in magnitude. For CFO, the increase in 2010 from 2009 is mainly due to the increase of net income and the positive accounts receivable from negative in 2009. The increase of CFO from year 2010 to 2011 is because of further increase of net income and depreciation and amortization, with another large portion of positive share-based compensation (related to major business).

The steady increase of CFI from year 2009 to 2011 consists of QIHU’s continuous investment in its fundamental business activities, while the huge increase of the CFF in 2011 is accountable to the IPO of QIHU during that year.

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The free cash flows of QIHU are 4.62, 10.76, and 45.99 million in 2009, 2010, and 2011, respectively. It increased 133% and 327% in year 2010 and 2011. The IPO of QIHU in 2011 has helped to its free cash flow’s increase during this period. This steady yet faster pace of increase of free cash flow for QIHU indicates its better ability to meet future financial obligation and good fundamental business development these years.

  • Cash Flow Comparisons

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The comparison of cash from operations (CFO) shows that QIHU’s scale of CFO is relatively small, as compared to those of SOHU Inc. (NASDAQ:SOHU), NetEase Inc. (NASDAQ:NTES), and Tencent Inc. (HKG:0700). However, the speed of the CFO increase for Qihoo 360 Technology (NYSE:QIHU) is higher than these competitors in the industry.

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The comparison of free cash flow between QIHU and its competitors illustrates a few things. At first, it indicates that all the competitors are bearing decreased free cash flow from 2010 to 2011, while QIHU is generating free cash flow at a faster rate than former year during this period. Another thing that can be extracted through this comparison is that QIHU’s free cash flow is still very small compared to all the other competitors except SINA Inc. (NASDAQ:SINA).

The two consecutive years’ decrease of SINA’s FCF is because, starting from 2010, it began investing much more money than usual years to expand its business in “weibo”, which is a twitter-like product in China. The big decrease of FCF in 2011 is due to both somehow decreased unlevered CFO and further increased CFI.

In conclusion, QIHU has a fairly good cash flow position. It has generated increasingly more cash flow in CFO due to its expanding business, and is investing at a good pace for the future development of the company. The cash financed by its IPO has granted Qihoo 360 Technology (NYSE:QIHU) enough funds for otherwise adverse economy condition or further business expansion. The FCF of QIHU is in a good trend because it’s both increasing in scale and growing in a fast rate.

 

4. Business Outlook for QIHU

Qihoo 360 Technology (NYSE:QIHU) recently has cooperated with certain smart phone manufacturing companies to produce 360-tailored smart phones for its customers in China. The selling of these smart phones has been well since their first launches. The embedded software of QIHU installed in these smart phones would not only protect these devices from virus invasion, but also enable users to surfing the internet using QIHU’s 360 browser and shopping by clicking the links generated by QIHU. When the number of these tailored smart phones reach to some scale, it is possible that they will generate large scale revenue and profit for QIHU.

Qihoo 360 Technology (NYSE:QIHU) has been providing vertical searching services for online videos. The revenue generated from this vertical searching service is not illustrated in QIHU’s financial report, probably because it’s still very small compared to other sources of revenue. Furthermore, QIHU has launched its so-called “general searching engine” (http://hao.360.cn/so/index.html) recently, which is directly competing with other searching engines in China, such as Google.cn (GOOG), Baidu.com (BIDU), and Sogou.com (SOHU). Due to its large user base for the related products, QIHU has the potential to attract users to search on its website on daily basis and consequently assemble large amount of enterprise customers to buy services from it, such as Key-Word search service and Search-Result-Ranking service.  The general searching industry has been proved as one of most profitable business in internet industry. Take BIDU for example, its 5-year average net profit margin is 41% and 5-year earnings per share (EPS) growth rate has been 85% (from Reuters). The business expansion of QIHU to the general searching industry needs careful scrutiny and financial data in the following quarters need to be examined. If this area of business had developed successfully in the future, it can generate real long term value for the shareholders of Qihoo 360 Technology (NYSE:QIHU).

For disclaimer and report with full financial data, download the pdf version: CV_QIHU_2012_Q1.pdf



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