Tencent’s (OTC:TCEHY) most recent results showcased renewed growth for the Chinese tech conglomerate. After a period of share price underperformance caused by doubts about its prospects, the recent revival has put the stock’s low valuation in the spotlight. Despite ongoing concerns tied to Tencent’s investment case, including the overall uncertainties surrounding Chinese equities, it seems that the stock now offers an attractive balance of risk and reward. Accordingly, I am bullish on the stock.
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Growth Re-Accelerating Across the Board
Tencent’s growth seems to be re-accelerating across the board after the company went through a few tough quarters last year. Specifically, here’s Tencent’s revenue growth in the five quarters prior to Q2-2023.
- Q1-2022 revenue growth: 0.12%
- Q2-2022 revenue growth: -3.1%
- Q3-2022 revenue growth: -1.6%
- Q4-2022 revenue growth: 0.5%
- Q1-2023 revenue growth: 10.7%
The relatively underwhelming growth metrics during Fiscal 2022 compared to the double-digit top-line growth Tencent investors were used to can be attributed to several factors. These include the Chinese government’s crackdown on big tech, the limitations imposed on the amount of time minors can play video games, and the ongoing tough macroeconomic landscape, which negatively impacted Tencent’s advertising businesses, among other challenges.
However, with Tencent’s businesses successfully absorbing these headwinds last year and the company continuing to invest in growth, Tencent’s performance in Fiscal 2023 has been nothing short of impressive. After posting robust revenue growth of 10.7% in Q1, Tencent’s most recent Q2 results showcased another quarter of excellent results, with revenues growing by 11.3% to $20.6 billion. Results were driven by a strong rebound in the traction of the majority of Tencent’s businesses.
Value-Added Services
Tencent’s Value-Added Services segment, which represents around half the company’s revenues, posted revenue growth of 4% to about $10.2 billion. This segment includes Tencent’s Social Networks sub-segment (20% of revenues), its Domestic Games sub-segment (21% of revenues), and its International Games sub-segment (9% of revenues), all of which performed well.
Tencent’s Social Media segment saw year-over-year revenue growth of 2% to roughly $4.1 billion, driven by increased revenue from mini-games and music subscriptions, while WeChat’s Monthly Active Users (MAU) reached a staggering 1.327 billion, up 2% compared to last year.
Further, while Domestic Games revenues remained steady year-over-year due to Tencent releasing not-as-commercial content in its most popular games after a strong first quarter, International Games revenues grew by 19% to around $1.7 billion, benefiting from the robust performance of VALORANT, NIKKE, and Triple Match 3D, as well as currency tailwinds.
Advertising
Tencent’s Online Advertising segment, which makes up 17% of revenues, also posted a strong rebound, with revenues growing by 34% to around $3.4 billion. While such a strong growth rate certainly benefited from comparison against the pandemic-affected, depressed period a year ago, management believes that Tencent outpaced the overall industry.
Management attributed Tencent’s outperformance to enhancements to the machine learning systems powering its ad platform and robust demand for Video Accounts ads. Further, advertising spending with ads grew at a double-digit rate year-on-year in every principal advertiser category other than transportation.
FinTech and Business Services
Lastly, FinTech and Business Services, which comprise 32% of Tencent’s total revenues, posted revenue growth of 15% to around $6.7 billion. Specifically, in FinTech Services, daily active users and transactions per user in commercial payments posted growth year-on-year. Online and offline payment volumes also grew in the double digits, as consumption spending generally picked up. Finally, Tencent’s wealth management business experienced healthy growth driven by assets under management (AUM) growth.
Strong Profitability Prospects Expose the Stock’s Undervaluation
Tencent is now seeing enhanced profitability prospects, primarily due to its strong revenue growth and the company’s massive scope unlocking economies of scale. In particular, the company’s gross, operating, and net margins in Q2 expanded from 43%, 22%, and 14% last year to 47%, 27%, and 18%, respectively. Accordingly, Tencent’s adjusted EPS landed at RMB3.875 ($0.53), up from RMB2.896 ($0.40 last year).
Based on the company’s half-year results and its ongoing momentum, analysts’ consensus EPS estimate for Fiscal 2023 currently stands at $2.12. This implies that Tencent stock is currently trading at a P/E of about 19.2x. Looking 12 months out, Tencent’s forward P/E stands at 16.2x, which is the lowest multiple the stock has traded at since 2005. Given the stock’s double-digit growth, massive moat, and unmatched economies of scale, this multiple offers both a great margin of safety and upside potential, in my view.
While one could argue that Tencent being a Chinese company comes attached with additional risks, which in turn, justifies shares trading at a discount, the company has a prolonged track of excellent execution and shareholder value creation. Hence, I believe the stock should be valued in line with its American peers.
Is TCEHY Stock a Buy, According to Analysts?
Turning to Wall Street, Tencent Holdings has garnered just a single analyst rating in the past three months. It’s a Buy rating, with TCEHY stock’s price target coming in at $50, implying 19.8% upside potential.
Final Thoughts
Tencent’s resurgence in revenues in Q2 marks a turning point for the tech titan. Its results underscore its resilience and adaptability to overcome challenges from regulatory shifts and economic headwinds. With robust growth across its diverse segments, Tencent’s strategic investments and scalable operations shine through.
Further, bolstered margins and the stock’s seemingly attractive valuation further accentuate its investment prospects. In an environment where uncertainties persist in Chinese equities, Tencent emerges as a compelling beacon of balanced risk and alluring reward.
