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Chinese tech stocks bouncing back from pandemic lows

Vikram Barhat  |  16 Jul 2020Text size  Decrease  Increase  |  
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China appears to be recovering well from the coronavirus-induced economic slump. Shaking off the 6.8 per cent contraction in the first quarter, resulting from the pandemic lockdown, the Asian economic giant’s economy is picking up faster than that of Europe and the US.

The Shanghai Composite Index rose 5.7 per cent to a two-year high, on 6 July, while the combined daily turnover on Shanghai and Shenzhen bourses clocked a whopping US$213.2 billion, a five-year high.

Investors may find attractive opportunities in the country’s tech sector. These Chinese tech heavyweights with global ambitions are turning up the heat in the fight for global dominance as they take on their American rivals. They enjoy favourable government policies and lax regulation and are beneficiaries of the growing affluence amongst China’s middle class, arguably the world’s best consumption story.

However, investors should note that it may be prudent to do due diligence and scrutinize each stock as these companies operate in an environment of relaxed oversight relative to their US and Canadian peers.

Alibaba Group Holding Ltd ADR (BABA)

Forward P/E: 28.74 | Price: US$249.21 | Fair value: US$258 | Value: Fairly valued |Moat: Wide | Star rating: *** | Data as of 16 July 2020

Chinese e-commerce juggernaut, Alibaba is the world’s largest online and mobile commerce company that operates online marketplaces, including Taobao and Tmall. China accounted for 68 per cent of revenue in 2019, while additional revenue came from international retail/wholesale marketplaces (7 per cent), cloud computing (7 per cent), digital media and entertainment platforms (6 per cent), among others.

Taobao and Tmall rang up gross merchandise volume of CNY 5.7 trillion (US$807 billion) in the year ended March 2019, more than Amazon and eBay combined in the year of 2018, representing a significant portion of China's CNY 8.0 trillion online shopping industry, based on data from iResearch.

“Alibaba is a big data-centric conglomerate, with transaction data from its marketplaces, financial services, and logistics businesses allowing it to move into cloud computing, media/entertainment, and online-to-offline services,” says Morningstar equity analyst, Chelsey Tam, who puts the stock’s fair value at US$258, adding that despite recent macroeconomic uncertainty due to COVID-19, the company is well placed on an extended runway of growth for China and Southeast Asia's digital commerce industry, adds Tam.

Tencent Holdings Ltd ADR (TCEHY)

Forward P/E: 39.84 | Price: US$69.81 | Fair value: US$77 | Value: Fairly valued | Moat: Wide | Star rating: *** | Data as of 16 July 2020

Tencent is a Chinese internet giant whose businesses include communication and social networking (Weixin/WeChat and QQ), online PC and mobile games, content (news, videos, music, and comics), utilities (email, app store, and mobile browser), the cloud, and financial technology. The firm has over 600 million monthly active users for QQ and 1.2 billion for Weixin/WeChat. The firm’s payment solution, Tenpay, enables closed-loop transactions in Tencent’s ecosystems.

The wide moat company’s dominant position in social networking and entertainment (gaming, online video, and online music) helps create strong network effect around its massive user base, says Tam, who recently raised the stock’s fair value by 30 per cent to HKD 597 (US$77), prompted by strong gaming sales.

Tencent’s adjusted return on invested capital significantly exceeds its cost of capital. “Tencent will generate excess returns on capital over the next 20 years via various monetisation sources, such as online gaming, subscriptions, advertising, and payment,” says Tam.

Baidu Inc ADR (BIDU)

Forward P/E: 20.20 | Price: US$125.05 | Fair value: US$191 | Value: 35 per cent discount | Moat: Wide | Star rating: **** | Data as of 16 July 2020

China’s answer to Google, Baidu is the largest internet search engine in the country with mid-70s mobile traffic share in the search market. The technology-driven company, which generates 86% of revenue from online marketing services, has been investing in AI technology, particularly autonomously driven cars.

The wide moat firm has built “an ecosystem around search and has successfully shifted to mobile internet by releasing various well-received mobile apps,” says a Morningstar equity report. The company boasts sustainable competitive advantage that flows from its network effect and intangible assets. “Baidu has built up a network effect and a positive feedback loop in its search business by leveraging its significant search traffic on both PC and mobile devices,” says Tam, who pegs the stock’s fair value at US$191.

Online video platform, IQiyi, has been a key growth driver (29 per cent revenue in first quarter of 2019) supported by demand for premium content and advertising.  “Baidu is also one of the largest and earliest companies to start AI investments in China,” adds Tam, noting Baidu uses AI to recommend feeds to the app’s users to generate advertising revenue.

Weibo Corp ADR Class A (WB)

Forward P/E: 16.45 | Price: US$35.90 | Fair value: US$45 | Value: Fairly valued | Moat: Narrow | Moat trend: Stable | Star rating: *** | Data as of 16 July 2020

The largest social media platform in China, Weibo boasts 392 million monthly active users and 172 million daily active users, mostly drawn there by the millions of key opinion leaders in entertainment, sports, and business circles. The company generates revenue from advertising on its platform.

“Weibo has been improving the content ecosystem and the strong presence of celebrities/key opinion leaders on Weibo is a differentiator,” says a Morningstar equity report. The social media platform has created a network effect between the users, who demand high quality content, content providers, and celebrities, who benefit from the opportunity to grow and monetize their followers.

Similar to the YouTube business model, Weibo’s video page has “both professionally-generated content and user-generated content, as well as the discovery zone (where users can find the popular discussion topics), and vertical videos focused on user-generated content,” says Tam, who appraises the stock’s fair value to be of US$45. Weibo’s competitiveness is built on network effect created by millions of active users that make it China’s largest social media company.

 Morningstar's Global Best Ideas list is out now. Morningstar Premium subscribers can view the list here.

 See also Morningstar Guide to International Investing

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is a Toronto-based financial writer.

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