An necessary lesson in investing is to always reassess the investing technique and determine errors if we made some. I used to be already bullish on $TENCENT(00700)$ a year in the past – and that was clearly a mistake, and I used to be too early with my shopping for advice. However, I’m nonetheless bullish about Tencent, and my investing timeframe is of a number of years and even a long time and never just some quarters. I’ll take a better have a look at Tencent as soon as once more and attempt to analyze if the corporate remains to be a great long-term funding and if the long-term bullish thesis remains to be intact.
Progress Narrative: Damaged For Now?
Tencent was one of many nice progress tales for a number of years and will report excessive progress charges for income quarter after quarter. Normally, Tencent wouldn’t simply report year-over-year progress, but in addition quarter-over-quarter progress. Nonetheless, in the previous few quarters progress slowed down and whereas income may nonetheless develop quarter-over-quarter, the expansion charges weren’t so excessive anymore. And within the final quarter (Q1/2022), income declined in comparison with the earlier quarter.
Tencent Company Overview Could 2022 Presentation
And whereas income declined quarter-over-quarter, it may nonetheless improve barely when year-over-year outcomes. Income elevated barely from RMB 135,303 million in the identical quarter final yr to RMB 135,471 million – 0.1% YoY progress. Working revenue nonetheless declined 33.9% YoY from RMB 56,273 million in Q1/21 to RMB 37,217 million in Q1/22. And diluted earnings per share declined even 51.1% YoY from RMB 4.917 in the identical quarter final yr to RMB 2.404 this quarter.
And it’s not shocking to learn, that margins additionally declined. Working margin for instance fell from 42% in Q1/21 to solely 27% in Q1/22.
Tencent Q1/22 Presentation
And whereas these outcomes weren’t nice, Tencent may a minimum of improve the mixed MAUs of Weixin and WeChat from 1,241.6 million on March 31, 2021, to 1,288.3 million on March 31, 2022 – a rise of three.8% YoY. Payment-based VAS registered subscriptions additionally elevated from 225.7 million to 239.1 million in the identical timeframe – leading to 5.9% YoY progress.
Addressing Progress Considerations
Tencent – in addition to many different Chinese language corporations – was struggling once more as a result of COVID-19 disaster and the ensuing lockdowns in lots of Chinese language cities. And though COVID-19 is accompanying us for greater than two years, we nonetheless should assume it is a slightly short-term challenge and never a long-term downside for Tencent. Over the last earnings name, administration talked about value management initiatives – which could even be a response to the pandemic.
Through the difficult first quarter of 2022, we implement value management initiatives and rationalized sure non-core companies, which can allow us to realize a extra optimized value construction going ahead.
And whereas it’s not a nasty concept to chop pointless prices to extend profitability and result in greater earnings per share, corporations are sometimes utilizing cost-cutting measures when the corporate is struggling. From this standpoint, Tencent reducing prices won’t be a great signal.
Tencent can also be struggling in its video games section. Whereas income from worldwide video games may develop 4% year-over-year within the first quarter, home video games income was down 1% year-over-year. One of many causes is the results of minor safety measures, which impacted energetic customers and paying person accounts. Tencent was additionally unnoticed of an inventory of corporations that had been granted new on-line gaming licenses by China’s nationwide gaming regulator in June 2022.
Tencent Company Overview Could 2022 Presentation
Internet marketing additionally declined 16% quarter-over-quarter and 18% year-over-year within the first quarter of fiscal 2022. Particularly advertisers in sectors reminiscent of FMCG, eCommerce and journey have lowered their spending considerably. This additionally led to a declining gross margin for internet marketing over the previous few quarters. And assuming an upcoming recession, I do not assume internet marketing will get better in a significant method within the subsequent few quarters. Nonetheless, I’m fairly assured that these struggles are solely short-term and Tencent will return on the trail of progress. And whereas I do not assume we are going to see comparable progress charges as earlier than (between 2017 and 2021 internet marketing grew with a CAGR of twenty-two%), we are able to in all probability see progress charges within the low-to-mid teenagers once more.
Tencent Company Overview Could 2022 Presentation
Contemplating the upcoming recession, I do not assume these progress points shall be resolved inside a couple of months, however they may almost definitely not be a problem in two or three years from now.
Intrinsic Worth Calculation
When wanting on the easy valuation metrics for Tencent, the inventory appears to be extraordinarily low-cost. However Tencent is a superb instance to display the constraints of easy valuation metrics. Proper now, Tencent is buying and selling for the most cost effective P/E ratio of the final ten years (it has been cheaper in the previous few weeks) and the inventory buying and selling for 14 instances earnings is clearly under the common P/E of the final 10 years (37.56). And when wanting on the price-free-cash-flow ratio, the image is analogous. Tencent is buying and selling for 18 instances free money circulation, which can also be under the 10-year common of 33.28.
At this level, we conclude that Tencent is a screaming purchase. However the easy valuation metrics do not take into consideration that Tencent was rising with a excessive tempo a couple of years in the past when the inventory was buying and selling for 40 instances earnings or free money circulation, and it’s struggling to develop proper now. And I feel it’s apparent for everyone that Tencent ought to deserve a special valuation a number of if it’s not in a position to develop at an analogous excessive tempo as earlier than.
As a substitute, we are able to use a reduced money circulation calculation which allows us to incorporate progress assumptions for the completely different years. As a foundation for our calculation, we frequently take the free money circulation of the final 4 quarters, however right here it will get a bit tough. In fiscal 2020, Tencent adjusted the free money circulation by subtracting funds for media contents and lease liabilities, along with subtracting funds for capital expenditures. This results in an adjusted free money circulation of RMB 90.1 billion within the final 4 quarters whereas free money circulation with out changes was RMB 127.7 million.
Tencent Company Overview Could 2022 Presentation
Now we are able to argue which quantity to make use of for our calculation and I might truly argue to make use of the upper quantity as I do not see funds for media content material as “actual” capital expenditures which are essential to maintain the essential enterprise operating. As a foundation for our calculation, we subsequently use a free money circulation of RMB 127.7 billion.
When calculating a bear case state of affairs, we are able to additionally calculate a bull case state of affairs. This state of affairs assumes that Tencent will have the ability to develop 20% once more in fiscal 2023 (after it struggled in fiscal 2022) and over the following decade progress will decelerate to six% progress until perpetuity. This results in an intrinsic worth of RMB 537 and leads to an intrinsic worth of HKD 629 and Tencent is buying and selling greater than 40% under its intrinsic worth.
Conclusion
Though Tencent is struggling proper now, I stay assured that Tencent will develop with a strong tempo within the years to come back. And if we don’t assume that Tencent can solely develop within the low-to-mid-single digits from now until perpetuity, the inventory appears to be undervalued. And contemplating the large financial moat Tencent has round its enterprise, I see it extremely unlikely that Tencent can solely develop within the low single digits from now until perpetuity.
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