Tencent stands out for its dividend, buybacks, strong margin expansion, increased cash, and plus WeChat in mainland China was quite strong this past quarter. However, we want to emphasize that any trades on Tencent or Baidu are momentum trades only. These are not shared with Pro or Essentials Members and are more like crypto, where technicals not only lead but are roughly 90% of the decisions we make around the position.
Below is research into Tencent’s financials with the gentle reminder that the technical analysis section below is the ultimate determining factor in how we manage the momentum position.
Revenue and EPS:
In the last earnings report, the conversion rate was stated to be based on USD1 to RMB7.0827. The currency rates may fluctuate in the upcoming earnings report and thus any USD numbers will not be exact.
Tencent is expected to report growth of 2% this quarter for revenue of $21.9 billion USD. This compares to $21.98 USD or RMB 155.2B in the previous quarter for growth of 7%. The company is expected to report growth of roughly 10% the next three quarters with the March quarter expected to be the bottom.
On an annual basis, 2023 reported growth of 10% for RMB 609B or $86B USD compared to a decline of (-1%) for RMB 554.6B or $79.6B USD for the full year 2022. Looking forward, Tencent is expected to report growth of 8.9% for USD $92.2B. The company is expected to report roughly 10% growth over the next few fiscal years with 2022 expected to be the bottom on an annual basis.
This quarter, the company is expected to report EPS of USD $0.64, or calculated to be RMB $4.53 EPS. This is flat from RMB $4.50 EPS reported last quarter yet the estimates represent growth on a year-over-year basis of 33%, up from RMB $3.10. Next quarter, Tencent is expected to report EPS of $0.64 or RMB $4.53 to be flat QoQ yet up 21% year-over-year.
On an annual basis, adjusted EPS is expected to grow 23.4% for USD $2.80, calculated to be RMB $19.9 EPS. This is up from RMB $16.3 adjusted EPS in FY2023. EPS is expected to grow 16% in FY2025 and 29% in FY2026.
Tencent focuses closely on Profit Attributable to Shareholders on a Non-IFRS basis (which is Non-GAAP adjusted net income for our reporting standards). In the most recent quarter, this was RMB $42.7B or USD $6B and was up 44% YoY.
EBITDA of $54B RMB or $7.6B USD was up 22.7% from $44B RMB in the year ago quarter. Adjusted EBITDA of $59.5B RMB or $8.4B USD was up from $49.6B RMB in the year ago quarter. The adjusted EBITDA margin increased to 38% up from 34% in the year ago quarter.
Margins:
Tencent is seeing expanding margins and this is a key piece as to why Tencent could see favorable price action.
Last quarter, the gross margin of 50.2% expanded from 43% in the year ago quarter and was up 120 basis points QoQ. Gross profit was up 25% from $61.8 RMB to $77.68 RMB or USD $11B.
Per management: “Importantly, our gross profit growth has consistently surpassed revenue growth due to the margins of our incremental revenue being significantly higher than the 50% overall gross margins for the entire company. This incremental revenue is generated predominantly from our leading social and payment platforms, which have already been built and had their costs covered. We now consider gross profit growth as a key proxy and, frankly, a better proxy than revenue growth for our organic growth given this shift in terms of the revenue mix.”
Last quarter, the operating margin of 27% increased from OPM of 20% in the year ago quarter yet decreased 400 bps from the previous quarter. The operating profits were $41.4B RMB or $5.8B USD.
The adjusted operating margin of 32% was up from 27% in the year ago quarter and is up 11-points in two years. This is down QoQ 400 basis points.
Per management regarding this efficiency: “We further enhanced our operating profit growth from gross profit growth through operating leverage. First, we streamlined operations and prudently reduced aggressive marketing expenditures. We perceive these measures as a less recurring strategy. Second and more importantly, we are committed to operational efficiency and disciplined resource allocation, which includes thoughtful staff distribution and effective marketing expense management. This approach ensures a focused organization and a lean cost structure moving forward.”
- The net margin of 18% for profits of 27.9 RMB doesn’t comp well against a one-time event in the year ago quarter, which had led to a net margin of 74%, but the 18% is in line with previous quarters.
- The adjusted net margin of 28% compares to an adjusted net margin of 21% in the year ago quarter. This is down 200 basis points QoQ.
Cash Flow:
Operating cash flow last quarter was RMB $54 billion or USD $7.6B, up 52% YoY. This represents an operating cash flow margin of 35% up from a margin of 25% in the year ago quarter.
Free cash flow of RMB $34.2B or $4.8B was up 48% YoY and represents a free cash flow margin of 22% up from 16% in the year ago quarter. Some quarters have a higher FCF margin than others, with Q3 and Q1 reporting a FCF margin of 33% and 35%, respectively.
The company has RMB 403.3B or USD at $56.9B in cash. This is up from USD 45.9 in the year ago quarter. The company has debt of RMB 348.6B or USD 49.2B for net cash of RMB 54.7B, which calculates to net cash of $7.72B USD.
Last quarter, the company spent RMB 7.5B in capex, which was up 33% YoY.
The fair value of shareholding in listed investee companies was RMB 550.7B or USD $77.8 billion. This has been trending upward but is a risk to have this much exposure to other companies.
The carrying book value of unlisted investee companies was RMB 337.3B or USD $47.6 billion. This has been flat over the past few quarters.
Dividends and Buybacks
Tencent pays an annual dividend and recently increased this by 42% to HKD 3.40 per share, which has a current exchange rate of $1 = $7.84. This would equal USD $0.43. Also, according to the last earnings report: “we intend to at least double the size of our share repurchases, from approximately HKD49 billion in 2023 to over HKD100 billion in 2024.” This equals roughly USD $12.7 billion.
Per the earnings call: “We believe this commitment to return at least HKD 132 billion or US $16.9 billion to shareholders during the year is well supported by our free cash flow, which was US $24 billion for the full year of ’23, along with our gross cash position of US $57 billion and our investment portfolio of US $126 billion.”
Key Metrics:
The Online advertising revenue segment reported RMB 39.8B up 21% YoY. This compares to 15% growth in the year ago quarter. This represents 19% of revenue with a gross margin of 56.8%. The gross margin was up 12.6 points year-over-year.
Fintech and Business services were up 15% YoY for RMB 54.4B compared to a decline of (-1%) YoY to RMB 47.2 billion in the year ago quarter. This represents 35% of revenue. Gross margin in fintech and business services is at 43.9% which was up 10.3 points year-over-year.
Revenue from value-added services (VAS) which includes international games, domestic games, communication and social, and also digital content, was down 2% YoY to RMB 69 billion and was also down 2% in the year ago quarter. Revenue from music-related and game-related livestreaming services decreased while revenue from the video accounts streaming service, music subscriptions and mini-games increased. This segment has a gross margin of 53.7% and was up 3.9 points YoY.
Despite the puts and takes in the segment, management stated the following highlights: “Our mini-games platform increased gross receipts by over 50% year-on-year. Our number of major hit games in China achieving both high DAU and substantial monetization increased from six in 2022 to eight in 2023 and in connection with games achieved double digit revenue growth and rose to 30% of games revenue.”
Management also stated they expect games to improve “from the second quarter of 2024.” There is also a popular game on desktop expected to launch on mobile in the second quarter called DnF mobile.
- Combined MAU of Weixin (mainland China) and Wechat (global app) is 1.343B up 2% YoY
- Mobile Device MAU was down (-3%) YoY to 554
- Fee-based VAS registered subscriptions was up 6% YoY to 248
Additional metrics:
- Tencent Video had 117 million paid subs. Long form video subscription revenue increased 1% year-on-year, driven by higher ARPU, while their video subscriptions declined slightly to RMB 117 million.
- Tencent Music had 107 million paid subs. Music subscription revenue increased 45% year-on-year on 21% growth in subscription count and 20% growth in ARPU.
Some highlights this past quarter include management stating: “Weixin Search has now achieved over 100 million DAU, up over 20% year-on-year, and Weixin Search content QV grew over 30% year-on-year. Our search revenue grew multiple times year-on-year in 2023 as we ramped up monetization on this under-monetized asset.”
Later it was also stated: “Weixin video accounts on the content consumption side, time spent increased over 80% year-on-year in the fourth quarter driven partly by DAU and mostly by time spent per user.”
Risks:
There are some risks associated with Tencent stock that are important to keep in mind, especially since United States stocks do not carry the same level of risk. The first is United States-China tensions, the second is that Tencent’s financials are unaudited, and third that Tencent is an over-the-counter stock which means the stock is not traded on an exchange.
Valuation:
Tencent trades at a PS ratio of 4.5 and a 4 EV/Sales which is in line with three year averages yet is low on a 5-year average basis. The 3-year median is 5 and the 5-year median is 6-8 EV/Sales
The company trades at a Fwd PE Ratio of 12 based on next year’s earnings compared to a 15 Fwd PE Ratio on a 3-year basis. However, the forward PE Ratio on a 5-year median is 30.
Price to FCF is 28.7 and has primarily traded higher except in 2022. The stock has traded as high as a 50 Price to FCF, but this is the absolute max it’s traded in the last few years.
Earnings Call:
AI driving Ad Revenue increase:
Per the earnings call:
“Moving to online advertising, our ad revenue was RMB 30 billion in the fourth quarter, up 21% year-on-year, benefiting from upgrades to our ad tech platform and more advertising revenue and video accounts. We generated increased ad revenue from all major categories except automotive with notable step-ups in revenue from internet services, healthcare and consumer goods categories. We refined our ad targeting by utilizing more real-time data in the AI powering our ad tech, enabling us to match target users with more relevant ads in a more timely manner across both our owned and our ad network properties.We refined our ad targeting by utilizing more real-time data in the AI powering our ad tech, enabling us to match target users with more relevant ads in a more timely manner across both our owned and our ad network properties.
Our video accounts ad revenue more than doubled year-on-year despite maintaining a very low ad load, due to increased video views and upgraded ad targeting. Weixin Search increased its revenue several-fold year-on-year in the quarter on growth on commercial queries and RPM.”
Later it was also stated:
Moving to communications and social networks, for Weixin video accounts on the content consumption side, time spent increased over 80% year-on-year in the fourth quarter driven partly by DAU and mostly by time spent per user, benefiting from our enhanced content recommendation engine […] Our video accounts ad revenue more than doubled year-on-year despite maintaining a very low ad load, due to increased video views and upgraded ad targeting. Weixin Search increased its revenue several-fold year-on-year in the quarter on growth on commercial queries and RPM.”
More on Artificial Intelligence
“Our Tencent Hunyuan foundation model is now among the top tier of large language models in China with notable strength in advanced logical reasoning. Our upgraded advertising AI model enables us to deliver better ad targeting and higher revenue.”
“In 2023, we also made notable progress in core technologies, especially those involving AI that will serve as our growth multiplier going forward. After deploying leading edge technologies such as the mixture of experts, or MoE architecture, our foundation model Tencent Hunyuan is now achieving top tier Chinese language performance among large language models in China and worldwide. The enhanced Hunyuan excels particularly in multi-turn conversations, logical inference, and numerical reasoning, areas which have been challenging for large language models. We have scaled the model up to the trillion parameter mark leveraging the MoE architecture to enhance performance and reducing [indiscernible] costs, and we are rapidly improving the model’s text-to-picture and text-to-video capabilities.
We are increasingly integrating Hunyuan to provide copilot services for our enterprise SaaS products, including Tencent Meeting and Tencent Docs, and we are also developing new gen-AI tools for effective content production internally. More generally, deploying AI technology in our existing businesses has begun to deliver significant revenue benefits. This is most obvious in our advertising business where our AI-powered ad tech platform is contributing to more accurate ad targeting, higher ad click-through rates and thus faster advertising revenue growth rates. We also see earlier stage business opportunities from providing AI services to Tencent Cloud customers.”
Technical Analysis
If we analyze the bigger trend in Tencent (TCEHY), there are two interpretations on the pattern in play.
- The Blue Count has the large correction that started in February of 2021 was actually a correction within a larger uptrend. This pattern would be playing out in 5 waves, and the current breakout would be the start of the final 5th wave higher. If this is in play, we will push past the $72 resistance, breakout to new all-time highs and then target the $115 – $140 region.
- The Red Count has the larger 5 wave pattern ending in February of 2021. This would imply that we are in a larger degree corrective bounce, which should take us to the $58 – $72 region, and potentially higher. We would be in the final push of a B wave, which is a 3 wave move.
If we zoom in on this move, what is worth noting is that both counts suggest a move to the $58 – $72 region.
From current levels, this is a 35% – 65% move. How TCEHY reacts in this region will determine if the more bullish blue count is in play. For any immediate entry, our stops would be between $39 – $36. If we catch the trend correctly, these stops would move higher with price.
Conclusion:
Similar to our analysis on Baidu, we foresee China’s push for domestic tech to be a force to contend with when it comes to AI. We could not be clearer that United States stocks are richly valued at the moment, and it’s quite difficult to find a good deal on tech in this market. Should we look toward China for alpha, it would be brief and a decision based on technicals. This means a position ranging from 1 day (should the setup fail) to a couple of months maximum. The weekly webinars and trade alerts are especially informative in this case, which is why the analysis is not shared with subscription tiers that do not have access to these Premium benefits. China is risky, Tencent is not audited, and is an OTC stock, and there are geopolitical tensions to navigate. With that said, the likelihood is high that we will attempt this half-court shot, so keep an eye out for the trade alert.
Knox Ridley, Beth Kindig, and the I/O Fund Analysts, contributed to this analysis
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