2023-11-16 05:04:16 ET
Summary
- Tencent's Q3 2023 earnings report shows promising trends in Fintech and Cloud revenue, as well as progress in its AI strategy.
- Domestic game revenue growth slightly missed expectations, while international games revenue growth fell short by 3 points.
- Tencent's AI strategy, particularly its transformer-based model Hunyuan, has shown significant progress and potential for application across various operational areas.
Tencent's ( OTCPK:TCEHY ) Q3 2023 earnings report , at first glance, presents a somewhat equivocal picture. However, a deeper dive into the numbers unveils some promising trends and strategic initiatives. From meeting revenue growth targets to surpassing expectations in Fintech and Cloud revenue and, importantly, the remarkable progress shown in their AI strategy, Tencent's performance in Q3 deserves a thorough examination. The following analysis will delve into the various sectors of the company's performance, providing insights into the nuances of Tencent's financial journey.
Q3 2023 Earnings Review
Upon initial review, Tencent's Q3 2023 earnings report presents a mixed bag, but a closer examination reveals promising details, especially when considering the company's compelling valuation (see Financial & Valuation section for more details). Let's unpack the numbers.
Domestic game revenue growth marginally missed the mark, registering a 5% YoY increase versus the predicted 7%. On the other hand, international games revenue growth stood at 14% YoY, a modest shortfall of 3 points from the forecasted 17%.
Despite this, the company witnessed a positive trend in the recovery of its advertising sector, which expanded by 20% YoY, falling slightly short by 2 points from the 22% consensus. This growth has been attributed to the robust performance of Video Accounts.
Interestingly, Fintech and Cloud revenue outperformed expectations, posting a solid 16% YoY growth, thereby exceeding the anticipated 13% consensus. This surge was attributed to the uptick in commercial payment activities and an increase in wealth management service revenue.
In terms of total revenue growth, the company managed a 10% YoY increase, closely aligning with consensus predictions. A standout from the report was the adjusted operating income which hit 42bn RMB, exceeding market expectations of 38.3bn by a commendable 11%.
Insights From The Call: AI Takes Center Stage
Based on the company's Q3 earnings call , Tencent's AI strategy has shown significant progress, particularly in the development of its transformer-based model, Hunyuan. We consider Tencent to be one of the leaders within China's AI domain, and the company is dedicated to continuously enhancing Hunyuan's performance. The next generation of the model will adopt a "mixture of experts" architecture, which we believe will further boost its performance.
In the process of developing Hunyuan, Tencent has also strengthened its broader AI capabilities. These include the ability to handle and process vast amounts of data, manage large computational clusters, and refine the AI fine-tuning procedure. Such capabilities are not limited to transformer-based models, and Tencent is using them in diverse areas of the company's operations.
Hunyuan has demonstrated notable effectiveness in generating text messages, a feature that has been particularly beneficial for various SaaS applications. For instance, Tencent leverages Hunyuan to provide meeting summaries in Tencent Meeting and document creation tools in Tencent Docs, enhancing productivity across the board. These AI-enhanced tools have already been made available to external customers.
Tencent's AI capabilities have also been integrated into customer service APIs and cogeneration tools, enhancing customer interactions and coding efficiency. Furthermore, AI is playing a critical role in the content creation process for advertising and game production, which is improving results for advertisers and game developers alike.
In terms of targeting technologies and content provisioning services, Tencent's AI capabilities have been instrumental, in our view. The use of AI has led to an increase in ad revenue and has expedited the growth of video accounts. Looking ahead, we believe that Hunyuan will offer valuable tools for enterprise customers and further enhance the efficiency of its advertising business. The company's long-term vision includes the integration of advertising and sales processes and the creation of a consumer-facing product that functions as a smart agent.
Tencent's AI strategy also considers the importance of hardware. The company has a substantial inventory of AI chips, which ensures the ongoing development of Hunyuan. However, Tencent acknowledges that future chip shortages might influence its ability to resell AI chips through its cloud services and is therefore exploring ways to optimize its AI chip usage and searching for domestic training chip sources.
Financial & Valuation
Note: All historical data in this section comes from the company’s 10-K filings, and all consensus numbers come from FactSet.
Looking at the company's financial trends, Tencent has demonstrated robust growth with a CAGR of 15.1% over the past three fiscal years. However, sell-side consensus anticipates a slowdown in revenue growth to 4.1% this fiscal year, totaling $84.6 billion, followed by a rebound to 11.5% growth in the next fiscal year, reaching $94.3 billion.
The company has shown impressive EBIT margin expansion, increasing by 12.5 percentage points from 29.5% to 42.0% over the same three-year period. However, consensus forecasts a substantial contraction of 1,249 basis points this fiscal year to 29.5%, followed by a minor expansion of 127 basis points the next fiscal year to 30.8%.
In terms of capital management, the company has been proactive, reducing diluted outstanding common shares by 0.8%. This suggests that management has been using share repurchases to more than offset shareholder dilution. As a result, EPS grew at a CAGR of 11.4% over the past three fiscal years, though this growth lagged behind its revenue growth.
Looking ahead, consensus predicts an EPS increase of 21.9% to $2.11 this fiscal year and a further increase of 17.3% to $2.48 the following fiscal year.
In terms of cash flow, the consensus estimates forecast a significant increase in free cash flow to reach $22,076 million this fiscal year, a 26.1% FCF margin. This compares to $14,021 million four fiscal years ago, a 26.4% FCF margin. Over the past four completed fiscal years, the company has generated an average FCF of $21,010 million, with an average FCF margin of 31.7%.
The company's capital expenditure as a percentage of revenue averaged 10.1% over the same period, suggesting a very high capital-intensity business. Despite this, the return on invested capital is solid at 17.2%.
The current dividend yield of 0.7% is 77 bps lower than the S&P 500's dividend yield, which is not bad for a growth stock.
Over the past year, TCEHY-US has outperformed the broader market, returning 8 percentage points more than the S&P 500, or 23.5% in absolute terms. The stock is trading flat against its 200-day moving average, is 19% below its 52-week high of $53.01, and is 30% above its 52-week low of $32.97 per share.
Based on the 12-month forward P/E ratio, the stock is currently valued at 16.2. This is in comparison to its 5-year average of 28.5, which typically fluctuates within a 2-standard deviation range from 14.8 to 42.2. Considering this range, the current valuation can be classified as relatively low when compared to its 5-year history.
Conclusion
Tencent's Q3 2023 earnings report indicates a company navigating the present challenges while strategically positioning itself for the future. Despite missing the mark slightly in domestic and international game revenue growth, the company demonstrated resilience and dynamism, particularly evident in the recovery of its advertising sector and the robust performance of its Fintech and Cloud services. Equally noteworthy is Tencent's ambitious AI strategy, with its transformer-based model, Hunyuan, showing significant progress and application potential across diverse operational areas.
Going forward, it's clear that Tencent's growth story is far from over. The company's financial trends indicate a strong potential for rebound in revenue growth, and its valuation suggests it may be an attractive proposition for investors. More importantly, Tencent's forward-thinking approach, demonstrated by its focus on AI and proactive capital management, places it in a strong position to navigate future challenges and capitalize on opportunities. As Tencent continues its journey, investors and observers alike should keep a close eye on how these strategies unfold and impact its overall performance.
For further details see:
Unpacking Tencent's Q3 2023 Earnings: A Mixed Bag With Hidden Gems