Hello Group (MOMO): Free cash flow generating activities are still too cheap to pass up

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If we look at the long-term chart of Hello Group Inc. (NASDAQ:MOMO), we see that equities remain largely oversold. The question now is whether stocks actually bottomed on the 29thand from last month or is there more carnage on the cards here. The MACD technical indicator has never been so oversold, but we may be starting to see green shoots against the histogram, which is very close to entering positive territory. Suffice it to say, the longer stocks can stay above those December lows, the more chance there is of a rally in the 10-month moving average, which would certainly be an encouraging sign.

Long Term MOMO Histogram Rising

Momo – Close to bottom?

StockCharts.com

The market remains skeptical, however, and from a purely fundamental standpoint, there is certainly merit in this view. Tantan, for example, which has been built for some time now to take over the business has disappointed so far. However, the company’s overall results aren’t actually that bad, as Momo’s core segment has actually outperformed in recent quarters.

The market, as mentioned, remains skeptical and the fact that Tantan didn’t really take center stage in the recent Q3 earnings call may lead investors to believe that his hype, ultimately, might not live up to expectations. Regardless of top line performance in Tantan, which fell significantly in the third quarter, which seriously upset the market is the number of paying users fell by 200,000 to 2.9 million.

Overall, in the Hello Group in the latest third quarter, sales were almost flat compared to the same 12-month period before, and net profit was RMB 403 million (down 12% from in the third quarter of last year). Wall Street will always bemoan negative earnings growth, but despite the company’s current growth issues, its net profit margin remains healthy in double-digit territory.

Wall Street will lead you to believe that high-growth companies are always the best investments, but that’s not always true. On the one hand, the valuation of the company remains extremely attractive in the Hello group. Another reason why growth isn’t always the answer is the scale of the company’s profitability and this is where we really want you to see the strength of Hello Group’s business.

For example, even if an equally cheap powerful competitor emerges and manages to grow its profits much faster than the Hello Group (as the industry does), investors should still research how much capital it costs the competitor to generate that growth. This is a very neglected area in that if a competing company, for example, needs to retain a high share of its profits to generate growth, then what happens to that company when its profits do not meet expectations? The sector’s return on invested capital is currently around 5%.

On the contrary, Hello Group’s return on invested capital currently exceeds 9% on a twelve-month average. The ROI measure is essentially a sound readout of how efficiently capital is invested in a company or industry. Sustainable business models always generate high returns on capital, leading us to believe that sooner or later the valuation of Hello Group will change for the better. Essentially, by not having to invest the lion’s share of the company’s profits, more of Hello Group’s cash flow can then become available to return to shareholders.

We can see exactly what I mean by looking at the Hello group treasury number of flows over the last four quarters. RMB 1.933 billion of operating cash flow was generated in the last four quarters. In addition, due to investment maturities exceeding investment purchases during the same period, an additional RMB 301 million was generated by Hello Group from investment activities. With this war cash hoard (remember – excluding negative background growth line), management was able to return RMB 853 million to shareholders through the annual dividend as well as RMB 1.061 billion through share buybacks. Suffice it to say that many “growth” companies fall far short of the same level of pay that we currently see in the Hello Group.

So, to sum up, in a business like Hello Group, the cash flow statement clearly shows what high margins and limited interest charges can do for a business, even in a negative earnings cycle. Even if the shares stay where they are for an extended period, we suspect that shareholders will continue to be rewarded handsomely through redemptions and the dividend and equity (net value) will continue to increase. These are reason enough to stick to our stance and continue to get paid while we wait. Stay long. We look forward to continued coverage.

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