Daiwa reiterated its "Buy" rating on TENCENT (00700) while adjusting its 12-month sum-of-the-parts (SOTP) based target price down from HK$710 to HK$700. This target implies an average forward price-to-earnings ratio of 19.3x for the 2026-2027 period. Key downside risks include weaker-than-anticipated performance in gaming and advertising sales, alongside higher-than-expected AI-related expenditures.
TENCENT's first-quarter revenue grew 9% year-over-year, slightly missing market expectations. This shortfall was primarily attributed to the timing of revenue recognition for its gaming business. However, non-IFRS adjusted net profit increased 11% year-over-year, meeting forecasts, supported by resilient margins despite a notable rise in artificial intelligence (AI) spending.
The report suggests that while discussing a timeline for AI monetization remains premature, there is increasing confidence in TENCENT's willingness and capability to invest aggressively in AI. The company has reorganized its AI teams, clarified its ecosystem roadmap, and benefited from improved domestic chip supply, supporting a strategy of "invest first, monetize later."
Value-Added Services (VAS) revenue underperformed, mainly due to weaker gaming revenue (gross billings). Domestic game revenue grew 6% year-over-year, but was impacted by a later Lunar New Year holiday, which shortened the revenue recognition window. International game revenue increased 13% year-over-year, slightly below expectations, affected by a high comparison base and the normalization of integration benefits.
While weak social network growth is seen as structural, domestic game growth is expected to accelerate starting in the second quarter of this year, benefiting from a multi-quarter catch-up in deferred revenue recognition.
AI investment accelerated in Q1, with capital expenditures reaching RMB 31 billion, an 18% year-over-year increase. Research and development expenses rose to RMB 23 billion, up 19% year-over-year. Daiwa anticipates AI spending, particularly capital expenditure, will rise significantly and be concentrated in the second half of the year.
Consequently, Daiwa modestly reduced its earnings per share forecasts for 2026-2028 by 2% to 4% to reflect the increased projections for AI investment.
Comments