Keep Inc. sprints towards profits as investors remain wary

China’s leading fitness app operator returned to revenue growth in the second half of last year, as it adjusted to a post-pandemic return to outdoor-related activities

Key Takeaways:

• Keep Inc.’s revenue grew 3.7% in the second half of the year, reversing a 2.7% decline in the first half on falling product sales
• The fitness app operator slashed its headcount and costs last year, helping to significantly boost its margins

By Doug Young

After sprinting out of the IPO gate with solid gains for its newly listed stock last summer, fitness app operator Keep Inc. (3650.HK) is looking increasingly like a Chinese edition of former U.S. health equipment sensation Peloton.

Both companies thrived during the pandemic as millions used their exercise equipment and videos to stay fit during long stretches of home confinement with few chances to enjoy more traditional activities like mountain climbing, sports and even trips to the gym. But with the pandemic now over, both companies are struggling to stay relevant.

Keep’s maiden annual results since its IPO last July showed its revenue declined last year from 2022, as a return to outdoor activities by many of its users sapped demand for the videos, online classes and equipment sales that are its main revenue sources. The company said it is adjusting by adding more products and services to meet demand for outdoor-focused activities in the post-pandemic era.

In the report, it noted how its monthly users began to rebound in the second half of last year after bottoming out in the first half. “(W)e are regaining momentum supported by the gradual rollout of our new outdoor initiatives,” it said.

Keep’s stock is sorely in need of its own new fitness training program in the brief period since its listing. After selling shares for HK$28.92 last July, in a Hong Kong IPO that raised a modest $40 million, the company’s stock rose as high as HK$36 as investors bet on its story of catering to millions of young middle-class Chinese with greater health consciousness than older generations.

But then the stock fell into a downward spiral last November, possibly due to growing concerns about China’s slowing economy. Whatever the cause, the company’s latest closing price of just HK$4.06 is down more than 80% from the IPO price. Its price-to-sales (P/S) ratio stands at an anemic 0.55, almost identical with the 0.56 for Peloton (PTON.US), but far behind the ratios of about 5 for healthier names like Garmin (GRMN.US) and Planet Fitness (PLNT.US).

Truth be told, Keep’s recent fall from investor favor doesn’t seem totally justified, at least not based on the information in its latest report. Granted, the company’s annual revenue fell 3.9% last year to 2.14 billion yuan ($296 million) from 2.21 billion yuan in 2022 – something no investor wants to see from a company selling itself on its high growth potential. But some simple calculations using data from the company’s mid-year report shows its revenue actually returned to growth in the second half of the year, rising 3.9% year-on-year, after falling 2.7% in the first six months.

That more detailed view is a theme that recurs throughout Keep’s latest report, namely that the company’s business started to rebound in the second half of the year as it made some important adjustments for a new post-pandemic environment.

Sagging product sales

Keep’s two main revenue sources are its service offerings, which include videos, online classes and other fitness materials; and its sales of products like exercise bikes and treadmills, as well as fitness clothing and food. Last year’s overall revenue decline owed entirely to a 16.8% drop in product sales, which were previously the company’s biggest single revenue source but fell to second place last year. Sales of services actually rose 11.4% for the year, partly offsetting the decline in product sales, and propelling that category to Keep’s revenue leader.

Keep blamed the drop in product sales to weak consumer sentiment, as well as the shift to outdoor activities post-pandemic.

While it’s never good to see one of your key revenue sources declining, the lower reliance on product sales should ultimately help Keep become more profitable over the longer haul since such sales typically carry far lower margins than sales of services. That shift was reflected in a marked improvement for Keep’s gross margin, which rose to 45.0% last year from 40.7% in 2022.

That greater focus on profitability was also a theme throughout Keep’s results for last year. Its sales and marketing, administrative and R&D expenses all fell by between 12% and 16%, or much faster than its revenue decline, as it tried to keep its costs under control. The company also reduced its headcount by 23% during the year, bringing it to 955 people by the end of 2023 from 1,243 at the start of the year.

At the same time, the company appeared to focus on quality over quantity in terms of its users, shedding ones who paid little or nothing for its app to focus on the higher-paying customers. Its number of average monthly subscribing members fell 12% to 3.19 million, but its average monthly revenue per user moved in the other direction, rising 18% to 6 yuan from 5.1 yuan in 2022.

That focus on efficiency helped Keep to narrow its adjusted loss by more than half to 295 million yuan last year, which excludes fair value changes of its convertible redeemable preferred shares and costs related to employee stock compensation, from a 667 million yuan loss a year earlier. And perhaps more importantly, the adjusted loss narrowed to just 72 million yuan in the second half of the year from 223 million yuan in the first half, showing the company is on the cusp of operating profitably.

Keep is also quite healthy financially, with just 10 million yuan in borrowings at the end of last year and 1.6 billion yuan in cash. Some might argue the company is being too conservative by failing to use its cash and credit more efficiently, though others might say such caution is merited due to China’s rapidly changing economic situation.

Keep really does look rather neglected by investors who perhaps worry that China’s increasingly cautious consumers could cut back spending on their personal fitness. But such concerns look quite overblown, especially in light of the company’s low valuation relative to its peers, as it bounces back from some post-pandemic transition pains.

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