In the past three months, the share price of Trade Me Group Ltd (ASX: TME) has plummeted 16.5%. As a long-term value investor this can be a great opportunity to pick up a value stock at a low price.
Trade Me is the leading online marketplace and classifieds business in New Zealand with a highly engaged community of close to 2.8 million members. It has a diverse and comprehensive range of listings, with listings across new and used goods, automotive, employment, real estate, accommodation, dating and group buying.
Revenues and net profits
According to TME's annual reports (below), since its listing in December 2011 its revenues have grown by 12.92% per annum from $125 million in 2011 to $180 million in 2014. At the same time however, its net profits have grown by just 5% per annum from $69 million to $80 million.
| Amounts in Millions | 2011 | 2012 | 2013 | 2014 |
| Revenue | 125 | 142 | 164 | 180 |
| Net Profit | 69 | 75 | 78 | 80 |
Source: Annual Reports
A quick look at Trade Me's 2015 half-year report, released in February, shows that this trend has continued in 2015 with revenue up 13% YoY to $96.9 million, but net profit after tax is up just 1.1% to $38.4 Million.
In the same report we find an explanation as to why this increase in revenues is not being reflected in bottom line profits.
CEO Jon Macdonald said, "Expenses were up 28 per cent year-on-year. This ramp-up in costs was reflected in net profit after tax of 38.4m, up 1.1 per cent year-on-year. We're continuing to invest in people, product development and marketing, as well as ramping up our sales and account management capability. We are convinced this is the right approach and believe that investment now will result in stronger market position and greater growth opportunities for Trade Me in the future."
Cash flows
As shown in the table below, from its listing in December 2011, Trade Me's 'cash flows after investing' are around $171.9 million. When you take into account the $127 distributed as dividends and $15.5 million in 'other financing cash flows' we can see that Trade Me has a 'funding surplus' totalling $29.3 million. This is a good sign for the company.
| Amounts in Millions | 2011 | 2012 | 2013 | 2014 | Total |
| Cash flow from operations | 67 | 56 | 80 | 100 | 303 |
| Cash flow from investing | 65 | 21 | 10 | 33 | 129 |
| CF after investing | 1.9 | 35 | 69 | 66 | 171.9 |
| Dividends | (6) | (55) | (66) | 127 | |
| Other Financing CF | (2.9) | (5.9) | (6.7) | 15.5 | |
| Funding Surplus | 1.9 | 25.9 | 8.2 | (6.7) | 29.3 |
Source: Annual Reports
Balance sheet
If we have a look at Trade Me's balance sheet we can see, cash has increased from $4 million to $38 million, equity has increased from $593 million to $625 million, but most importantly debt has grown significantly from $0 to $153 million in 2014. Its debt to equity is still manageable at 18%, and return on equity (ROE) is good at around 12%.
| Amounts in Millions | 2011 | 2012 | 2013 | 2014 |
| Cash | 4 | 30 | 41 | 38 |
| Debt | 0 | 129 | 139 | 153 |
| Equity | 593 | 500 | 554 | 625 |
Source: Annual Reports
Competitive Advantage
As New Zealand's largest online auction site, Trade Me's competitive advantage comes from its 'network effect'.
The network effect is the effect that one's use of a good or service has on its value to other users. Lists tend to have a positive feedback loop – the more users a site attracts; the more others will want to use it. The more customers view the site, the more suppliers want to list their products. The more products listed by suppliers, the more customers view the site and so on.
Other companies that enjoy the same benefits of the network effect include REA Group Limited (ASX:REA), Seek Limited (ASX:SEK), and Carsales.Com Ltd (ASX:CAR).
Verdict
For me, there's a lot to like about Trade Me. It has a strong brand awareness and network effect. It has a strategy of developing complementary offerings within its portfolio. The company has made a number of acquisitions including Harmoney Limited, MotorWeb, LifeDirect, Holiday Homes, and Paystation.
It has strong growth in revenues and cash flows, but its net profits continue to remain flat. Trade Me's margins in the near term could come under pressure as it seeks to invest in other businesses to drive top line growth. Thin margins leave the company vulnerable to a slowdown or economic downturn in New Zealand.
Lastly, New Zealand is a country of just 4.5 million people, the question I keep asking myself is, "How much potential growth is there for Trade Me in the New Zealand market"?
In terms of investment, for the moment I'll be sitting on the side-lines and keeping Trade Me on my watchlist.
