Tencent China stocks article

Tencent has good growth prospects over a 10-year timeframe

The Asia selections in Morningstar's global equity best ideas list for July include a newly added Chinese bank, alongside incumbents from the consumer cyclical, industrial and technology sectors.

Narrow-moat Agricultural Bank of China (ABC) is Morningstar's preferred name among Chinese financials. This is attributed largely to its strong deposit base and presence in the "underserved rural market", according to Morningstar's analyst team in Asia, headed by Lorraine Tan, director of equity research for the region.

"The bank is less impacted by intensifying deposit competitions from joint-stock banks and Internet banks. We expect ABC will continue its net interest margin expansion amid tight liquidity.

"Besides, we believe the market has yet to factor in gradual fundamentals improvement at ABC, including industry-leading provision level, improving credit quality, and a stronger capital position following the upcoming private placement in 2018," according to Morningstar's Global Equities Best Ideas.

Smoother roads ahead

Among five-star stocks from China, Great Wall Motor Co is trading at a 56 per cent discount to Morningstar's fair value estimate (FVE). Morningstar's latest equity analysis on the company notes its 2017 earnings were "relatively disappointing on higher sales and marketing expense and research and development costs [but] we remain optimistic on the company’s midterm outlook". But analysts are upbeat given the upcoming rollout of new vehicle models, including the company's best-selling Haval H6 and mid-range SUVs, which should lead to margin recovery.

"We reaffirm our view that Great Wall Motor’s operational difficulty is most likely limited to 2017. The company’s improving product mix toward midrange Wey SUVs and increasing localisation of high-value components…warrant a solid long-term net earnings growth outlook."

Morningstar anticipates this should drive a 31 per cent net earnings compound annual growth rate (CAGR) on the back of a 13 per cent top-line CAGR between 2018 and 2021.

Five stars but not all hunky dory

In Chinese industrials, Hong Kong-headquartered retail conglomerate CK Hutchison Holdings has a five star Morningstar rating and trades at a 33 per cent discount to FVE – though it lacks a moat.

"We continue to believe that CK Hutchison Holdings is relatively undervalued, with a current price that more than reflects a business outlook that is not all hunky dory.

"Improving macro conditions should provide a buffer to the group’s profits over the next few years despite competition challenges. CKHH’s earnings growth took a hit in 2016 on pound sterling weakness, but this impact has dissipated and stronger currencies against the US dollar-pegged Hong Kong dollar are expected to translate favourably," according to the latest Morningstar equity report on the company.

Though competitive pressures are likely to erode market share from mid-2018, and a Morningstar outlook of "flattish profit, Hutchison’s emerging Asian telecommunications operations should see rising profits from a low base".

Riding on clean air policy

Also within consumer cyclical, Beijing Enterprises Holdings is another five-star stock Morningstar regards as undervalued, and with a narrow moat of competitive advantage.

Analysts note China's long-term promotion of natural gas over coal as a cleaner fuel source remains a positive driver for Beijing Enterprises – given the firm derives about 75 per cent of group net income from natural gas transmission and distribution. 

With a monopoly on Beijing's natural gas distribution, it also owns the Shaanxi-Beijing gas transmission pipeline, the main artery for the natural gas supply to Beijing and northern China.

"We think these high quality well-located assets, coupled with the firm's unique customer mix with gas-fired power and heating plants in the most prominent demand segment, are the key strengths that allow the company to benefit from supportive policies promoting clean air in Beijing," says the Morningstar report.

One of the BAT pack

Having grabbed plenty of attention in the global financial press – as one of China's so-called BAT pack of companies, alongside Baidu and Alibaba – Tencent has good growth prospects over a 10-year timeframe. "We think Tencent has numerous growth opportunities behind our forecast 10-year revenue compound annual growth rate of 34 per cent and our adjusted operating profit CAGR of 25 per cent," according to Morningstar.

Analysts point to higher monetisation of mobile games, expansion of game genres, e-sports, and increased willingness to pay for subscription-based content on the part of Chinese consumers. 

"Online advertising revenue is expected to see a 10-year CAGR of 26 per cent, driven by continuous shift of marketing budgets to social media and video – in both of which Tencent has a stronghold," says the Morningstar report. "Improving targeting technologies, and the gradual yet inevitable increase in advertising inventories in the long term."

This should be driven further by expansion in the merchant network globally to serve outgoing Chinese customers' – meaning more payment revenue – along with increasing migration to cloud-based solutions and artificial intelligence.

 

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Glenn Freeman is senior editor, Morningstar Australia.

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