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Tencent: Reasonably Valued Cash Cow Despite Mixed Results
Stock Analysis & Ideas

Tencent: Reasonably Valued Cash Cow Despite Mixed Results

Tencent Holdings Limited (TCEHY) is one of China’s elite behemoths that have been transforming the country’s economy dramatically over the past couple of decades. The company is involved in practically every technology sub-sector, unlocking operating efficiencies to a scale that only a handful of other companies can execute.

Tencent’s stock features one of the greatest shareholder value creation stories in history, let alone in the Chinese and Hong Kong stock markets. Specifically, in its original Hong-Kong listing, Tencent shares have returned an outstanding 45,000%+ since the company’s IPO. This, in fact, includes the substantial year-to-date decline in the stock price.

Tencent’s growth has slowed down notably lately, with the Chinese Government’s crackdown on big data and softening economies of scale, affecting the company’s metrics. That said, growth remains impressive in some of Tencent’s segments, while the company should continue to be a cash cow with multiple moats to support its longevity and future success.

I am bullish on the stock.

Mixed Results 

Tencent reported its Q4 results last week, with numbers coming in somewhat mixed.

Adjusted EPS came in at $0.40 (All figures have been converted to USD), implying a 2.3% gain year-over-year, while total revenues rose 8% to $22.6 billion. In fact, this mars another quarterly revenue record-high for Tencent.

Revenues were boosted by improved results in Tencent’s value-added services and domestic and international gaming segments. They grew 7%, 1%, and 34% in each of these segments, respectively.

On the more worrisome side of the report, Tencent’s social media division was adversely impacted by China’s regulatory crackdown in the industry. Advertising revenues from social media declined ~13% to $3.38 billion, even though Weixin’s daily active advertisers grew by over 30% compared to last year.

Still, the report had plenty of highlights. Fintech and Business Services’ revenues, for instance, rose ~25% to $7.53 billion. Further, despite Tencent’s continuous investments in all of its businesses, the company still managed to sustain rather juicy margins. Specifically, gross and net margins stood at 43.9% and 17.9%, respectively.

Capital Returns & Valuation

Up until recently, Tencent featured an 11-year dividend growth streak. However, the track record has now ended, with the company announcing it intends to pay a dividend of HKD1.60 per share corresponding to Fiscal 2021, similar to the year before.

However, with its share price on a decline for quite a few months now, Tencent significantly boosted its share repurchases. The company repurchased around $786.3 million worth of stock during Fiscal 2021, 175% more than last year.

Still, this amount is only a fraction of Tencent’s market cap and hardly enough to lift shares higher. The result of a declining share price against improving results has led to a steep valuation contraction.

Assuming the company posts EPS closer to $2.20 next year, implying modest growth (FY 2021 was ~$2.04), Tencent trades close to 21.5 times its forward earnings, one of the lowest multiples the stock has seen over the past decade.

Wall Street’s Take

Turning to Wall Street, Tencent Holdings has a Strong Buy consensus rating, based on six unanimous Buy ratings assigned in the past three months.

At $76.88, the average Tencent Holdings stock projection implies 63.3% upside potential.

Conclusion 

Tencent’s latest results were weak in some parts but assertive in others. In general, Tencent’s expansion pace has certainly slowed down, and the halt in dividend growth was certainly not pleasing. That said, buybacks did increase, and the company remains very profitable.

Due to its attractive valuation and Tencent’s general moat in the Chinese tech universe, I am bullish on the stock. Still, investors should be wary of the risks related to Tencent’s slowdown.

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