2023-05-23 14:12:19 ET
Summary
- Tencent outperformed expectations in Q1.
- With the company levered to all the right parts of the Chinese economy, the re-acceleration looks poised to continue.
- Relative to the 2023/2024 earnings growth potential and the basket of growth options within its portfolio, the stock is reasonably priced.
Tencent ( OTCPK:TCEHY ) defied the quarterly earnings letdowns at many of its Chinese tech peers, posting a better-than-expected Q1 2023 result on a re-acceleration across its gaming (+11% YoY) and advertising (+17% YoY) segments, as well as a return to growth in its cloud business. The revenue beat was accompanied by good expense discipline and operating efficiency, helping its operating profitability outpace the top-line growth trajectory. With Tencent exposed to all the right growth segments (advertising, gaming, fintech) ahead of a services-led China recovery and an increasingly tech-friendly regulatory backdrop, the company is well on track to deliver more beats and raises in the coming quarters.
There’s plenty to like here for long-term investors as well, given its competitive positioning within the AI industry in China, along with its unique ability to leverage AI to create new growth opportunities across its vast social/tech ecosystem. In the meantime, the resumption of its buyback post-Q4 and the approved dividend payment increase for 2022 present additional catalysts, more than offsetting any potential overhang from Prosus ( OTCPK:PROSF ) share sales ahead. The valuation doesn’t screen that cheaply at the current mid-teens P/E but is well-justified by the quality of the Tencent portfolio and long-term earnings growth potential.
Gaming-Led Q1 Rebound Marks a Potential Inflection Point
Tencent’s Q1 results were strong across the board, led by a return to growth in the domestic games business (+6% YoY). As expected, the company’s proven titles led the way, namely the ‘Honor of Kings’ and ‘CrossFire’ franchises, helped by content updates and increased marketing efforts during the quarter. Building on the successful monetization of its team-based gaming models, newer titles like ‘Battle for the Golden Spatula’ (an iteration of Riot Games’ Teamfight Tactics for Chinese audiences) also saw a +30% YoY growth in gross receipts. Other domestic gaming successes for the quarter include shooter game ‘Arena Breakout’ (new highs in the user base and gross receipts) and arcade-style action title ‘Metal Slug’ (#1 ranked new action game).
Tencent
Coming off a relatively low base, Tencent’s overseas gaming revenue also outperformed at +25% YoY, primarily due to the +30% YoY growth in gross receipts for its PC game, Valorant, following new item and game mode updates. Its other evergreen overseas gaming franchise, ‘PUBG Mobile,’ also saw sequential daily user growth following gameplay updates. The strong performance of newly launched games like ‘Goddess of Victory: Nikke’ and ‘Triple Match 3D’ were positive as well, signaling that the company is now past most of the transitional challenges faced post-COVID. In sum, Tencent’s approach to penetrating overseas gaming by owning quality studios and acquiring incremental growth appears to be paying off here.
Tencent
Elsewhere, the domestic consumption-led Chinese recovery is filtering through to revenues via a sharp rebound in offline payment activities. Together with online payment strength, Tencent’s fintech segment also outperformed, delivering double-digit YoY growth in Q1 2023. Perhaps more surprising was the strength of the cloud business, which also returned to YoY growth (vs. YoY declines in prior quarters), despite ongoing price cuts by an industry peer. With cloud now leaner and more profitable post-restructuring, the business is better positioned to navigate the headwinds.
The combination of higher revenue and lower expenses (due to an increased focus on efficiency post-COVID) led to a positive operating leverage effect, with the non-GAAP operating margin expanding 6% YoY to 29% (32% non-IFRS). Non-GAAP EPS also rose low-double-digits YoY despite a lower non-operating income contribution. Still, these results are impressive, and with newer, higher-margin income streams (Video Accounts, Mini Programs, and e-commerce livestreams) in the pipeline, we are likely at an inflection point in the Tencent recovery story.
Tencent
Positive Near-Term Outlook for the Core Business; Lots to Like Long-Term as Well
On the back of Tencent’s robust YoY growth in gross receipts for its franchise titles and newly launched games, underwriting a return to more healthy and sustainable YoY growth in the coming quarters seems perfectly reasonable here. There’s ample room for upside as well – the success of ‘Valorant’ overseas likely portends a new growth driver once the title enters the domestic market. Plus, the reversal of China’s regulatory stance (in line with the government’s focus on economic development) paves the way for more pipeline launches, most notably the action role-player ‘Lost Ark’ title later this year. Management has guided to similar near-term strength throughout the rest of its businesses as the consumption-led rebound in China continues to take shape.
For the long-term, management’s reiteration of AI as a potential source of new product innovation is compelling, given the scale and breadth of its ecosystem. Nothing concrete yet, though, with management citing content generation as the current focus, along with improving service quality (i.e., via ‘smarter’ digital assistants). In the immediate future, all eyes will also be on Tencent Cloud as a key ‘picks and shovels’ player in the Chinese AI boom. Its cutting-edge, high-performance compute capabilities place the business in pole position, though an ongoing price war with the likes of Alibaba Cloud ( BABA ) will weigh on near-term margins.
Cost discipline will also continue to be a feature in future quarters, as the pandemic looks to have made operations structurally more efficient. Additional margin drivers include incremental monetization, for instance, via enhanced value-added services, and new, margin-accretive income streams like e-commerce live streaming (good take rates, less marginal costs). Net, in an uneven growth backdrop, Tencent offers good earnings growth visibility in its core business, along with a basket of growth options (new game launches, incremental monetization options, AI, etc.).
Tencent
The Re-Acceleration Begins
The mixed quarterly results posted by Alibaba and JD.com ( JD ) for Q1 lowered expectations heading into Tencent’s earnings announcement. But the company’s earnings beat offered nothing but positives, as its key business lines (gaming, advertising, and fintech) outperformed across all metrics. The higher earnings growth algorithm is likely here to stay. The 2023 macro backdrop is improving for Chinese services post-reopening, while a more benign regulatory environment clears the path for an accelerated game release schedule and monetization. In the meantime, the company has made promising gains in the generative AI space in China; future AI integrations across its ecosystem present massive growth catalysts over the mid to long term. Additional upside catalysts include increased shareholder returns (mainly via the 50% increase to dividends in 2022), along with an accelerated buyback run-rate (>$400m YTD). All in all, the stock remains reasonably priced at current levels relative to an >20% EPS growth outlook through 2023/2024.
For further details see:
Tencent: The Re-Acceleration Begins