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Members Area Signal from Noise Alibaba, Look Attractive on Strong Growth Pote

Signal from Noise

Alibaba, Tencent Look Attractive on Strong Growth Potential

January 8, 2020

Vito J. Racanelli SENIOR EDITOR & MARKET INTELLIGENCE ANALYST

– Both are among the dominant global players and in their various businesses in

– China e-commerce markets fast growing; BABA, Tencent comparable to AMZN, FB

– Even after stocks up big, potential for shares to continue outperforming the SPX

The shares of Holding (BABA) and Tencent Holding (TCEHY/700 HK) have been on a tear lately, up 28% and 19%, respectively. Despite that—or perhaps because of it —I think both stocks are attractive in the long term. A good 2020 is FS Insight, Bloomberg potentially in store too, if, as I expect, the bull market canters forward.

Maybe you’re saying to yourself, “Hey, it’s too late. The train has left the station.” I beg to difer. Given the global growth potential available to both these frms, I maintain there’s more room to rise. Investors should compare these two Chinese e-commerce giants to peers (AMZN) and Facebook (FB). Like the latter, BABA and Tencent aren’t at the beginning of their growth story, but the Chinese frms sit at earlier points in their growth trajectory than the American behemoths.

In a nutshell, both these stocks look like an option on continuing years of growth in China but also in the rest of the world. I think that’s a likely scenario.

While both stocks have performed well of late, that momentum is a change from the past few years. Since the end of 2017, AMZN shares are up over 60%, but BABA’s are up 27%. Over the same period, FB has risen over 20%, but Tencent is down 4%. BABA is only now surpassing its 2018 high, while Tencent is below its 2018 high. Remember, too, that China’s stock markets have underperformed sharply in the past decade.

I think the key descriptive term for both BABA and Tencent is “double digit percentage growth.” In many of each frm’s most important metrics, there is a strong expectation that will continue this year and probably beyond. The similarities to Amazon (AMZN) and Facebook (FB) in an earlier stage of corporate development are too strong to ignore.

A couple of things have been holding back the Chinese shares. The many months long U.S.-China trade spat has kept sentiment from improving. Violence in and the possibility that domestic regulatory oversight will increase hasn’t helped. However, once it became clearer late last year that the trade tension was easing, the stocks took of. Additionally, both companies had some minor hiccoughs in results. For example, Tencent online sales were weak in the recently reported third quarter.

Nevertheless, these large conglomerates are business engines with many cylinders and most are fring nicely. Both have their hands in various internet pies, from online ads and shopping, fast growing cloud services and big data, to mobile gaming, fnancial and consumer services—and reportedly even digital currencies.

A list of all their businesses would be too long to publish here. Sufce it to say there’s plenty of growth left in a country of 1.4 billion people, where it is estimated nearly one billion haven’t ever ridden on an airplane. There are hundreds of millions aspiring to the middle class and that’s good for both BABA and Tencent.

To the average young, upwardly mobile Chinese, both Alibaba and Tencent are integral to their everyday shopping and activity in general. Until recently, China focused on export growth, but the future will likely see a big rise in domestic consumption. Even if China’s economy is slowing a bit, it has four times the U.S. population and is still expanding faster than the U.S. It will likely do so for years to come. Let’s look at the most recent results. In its second quarter ended Sept. 30, BABA saw sales jump 40% and a 3% sequential increase in active customers to 693 million. Lest you think lightly of that, 3% is 19 million customers. A recent Bloomberg report noted that BABA’s robust growth should continue as it penetrates China’s lower-tier cities.

Meanwhile, Tencent posted a 21% revenue increase in the same quarter, but, as noted, media ads were down 28%. A Bloomberg report said that might recover as video- content restrictions have begun easing.

Each company has its strengths. Here is a short list of interesting statistics: Tencent has a 50% share of China’s mobile gaming market, currently $149 billion annual revenue, and is the leader in mobile apps. Video games, high margin services, are forecast by Frost & Sullivan to rise to 14% of spending in 2021 from 12% in 2017.

Tencent’s WeChat social network is ranked number 5 in the world at 1.1 billion members. BABA has just 20% of the sales AMZN has but 2/3 of the proft. BABA’s operating margins are roughly triple AMZN’s, and its video site is China’s biggest.

Yes, one issue is that the rule of law and governance is weak in China broadly speaking. But one rule seems to be respected even by the Chinese authorities and that Source: FS Insight, Bloomberg. Market Cap for Tencent was calculated is to let their companies using HKD/USD exchange rate as of 1/7/20. make profts. I’m only being a little facetious here. Just as the U.S. Federal government keeps an eye out for Boeing’s interest—whether you care to admit this or not—the Chinese government does the same for BABA and Tencent. Some investors are concerned by the China’s new anti-trust law, but this only confrms to me that both BABA and Tencent are moving along the same curve as AMZN and FB, both of whom have come under considerable increased scrutiny from U.S. regulators.

One thing that bothers me is that Wall Street absolutely loves these stocks, with the overwhelming majority of analysts holding a Buy rating on both. That kind of one-sided enthusiasm invites complacency. Besides the fundamental outlook, BABA is much cheaper than AMZN. While Tencent is more expensive than FB, I think it has more growth potential. (See nearby table.)

I’ll add that our technical analyst, Robert Sluymer, likes the technical picture for both BABA and Tencent. Late last year, they showed a classic progression of major cycle lows developing following 12-18 months bear markets. He thinks both are early in a new bull cycle and that investors should use near-term pullbacks to accumulate. Where I could be wrong: The U.S-China trade discussions could yet founder and a China crackdown in Hong Kong would hurt sentiment.

Bottom Line: Even after a recent big stock runups, it seems to me that the runway for BABA and Tencent remains long.

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Vito J. Racanelli SENIOR EDITOR & MARKET INTELLIGENCE ANALYST

Disclosures (show)