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Three Chinese tech stocks that are taking over

Vikram Barhat  |  15 Mar 2019Text size  Decrease  Increase  |  
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China's trade spat with the US and headlines about slowing growth appear to be obscuring the Asian economic giant's undeniable commercial prospects and attractiveness as investment destination, particularly its burgeoning tech sector.

Investors shying away from China may be missing out on opportunities as the country marches towards global tech dominance. No doubt China's global ambition has generated its share of controversies, ranging from the arrest of the CFO of Chinese consumer electronics giant Huawei to allegations of IP Theft, and military use of artificial intelligence.

However, its obsession with tech supremacy has also given rise to a robust tech sector with domestic behemoths that are now increasingly challenging the dominance of American tech powerhouses. China’s audacious vision and rising prominence in AI is evident from the fact that the country is now accounting for 48 per cent of global AI funding dollars compared to the US at 38 per cent.

Despite fears to the contrary, China’s tech sector growth story is far from over. A large and still growing population of internet users, explosion of smartphones, social media and the rapid rise of online shopping conspire to create a long runway of growth for leading Chinese tech titans. With differentiated product offerings, a solid grasp of local consumer trends, unmatched e-commerce capabilities and a staunch government backing, the following companies are spearheading China’s tech revolution and are well positioned to be its biggest beneficiaries, according to Morningstar equity research.

  • Baidu Inc ADR
  • Ticker: BIDU
  • Current yield: -
  • Forward P/E: 17.92
  • Price: US$168
  • Fair value: US$262
  • Value: 36% Discount

Data as of 14 March, 2019

With more than three-quarter share of the search market, Baidu (BIDU) is the largest internet search engine in China. The company generates 86 per cent of revenue from online marketing services.

The technology-driven company has been actively investing in the field of AI. “It has been evolving from a mobile-first to an artificial-intelligence-first company,” says a Morningstar equity report, noting that it remains the technology leader in China despite facing growing competition from other internet companies.

The possibility of some of Baidu’s AI-based bets paying rich dividends has prompted Morningstar equity analyst, Chelsey Tam to say: “A potential Baidu breakthrough in AI-based apps or services, including autonomous driving, is the key upside risk for this company.”

As well, the company is fully tapped into the fast-growing streaming content market. Its video platform, IQiyi, has been a key growth driver for the past three years. Known as the Netflix of China, IQiyi, which made its trading debut last year, rang up a staggering 55 per cent year-over-year revenue growth in the fourth quarter.

“Advertisers are willing to pay higher prices for search ad purchase as advertisers can reach the largest potential audience,” says Tam, who puts the stock’s fair value at US$262 per ADR.

  • Alibaba Group Holding Ltd ADR
  • Ticker: BABA
  • Current yield: -
  • Forward P/E: 26.53
  • Price: US$180.70
  • Fair value: US$240
  • Value: 25% Discount

Data as of 14 March, 2019

The world’s largest online and mobile commerce company, Alibaba (BABA) generates nearly three-quarters of its revenue from China’s online marketplaces. The tech major’s other sources of revenue include digital media and entertainment (8 per cent), international retail (8 per cent), and cloud computing (5 per cent).

“Over the past few years, Alibaba has transitioned from a traditional e-commerce company to 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 a Morningstar equity report.

The tech firm operates China's two most popular online shopping marketplaces -- Taobao and Tmall – which underpins Alibaba’s sustainable competitive advantage and helps drive retail revenue per active user that far outpaces that of its rivals, says Morningstar sector strategist R.J. Hottovy, whose US$240 per ADR fair value estimate incorporates a revenue growth rate north of 33 per cent from 2019 through 2023, including 50 per cent growth in 2019.

Although online retail remains Alibaba’s key revenue generator, its cloud computing business, AliCloud, “is likely to develop into a more significant cash flow contributor over time,” says Hottovy.

  • Tencent Holdings Ltd ADR
  • Ticker: TCEHY
  • Current yield: 0.26%
  • Forward P/E: 30.49
  • Price: US$45.62
  • Fair value: US$64
  • Value: 29% Discount

Data as of 14 March, 2019

Chinese internet monolith Tencent (TCEHY) provides an array of services including communication and social networking (Weixin/WeChat and QQ), PC and mobile games, content (news, videos, music, comics and literature), utilities (email, app store, mobile security, and mobile browser), and the cloud. The firm boasts aggregate monthly active user base of over 800 million for QQ and 1 billion for Wexin/WeChat.

“Tencent is also ranked No 1 in gaming revenue globally, 72 per cent higher than its next-largest rival Sony,” says a Morningstar report, noting that the company monetises its social-networking platforms through up-selling and cross-selling.

Tencent’s wide moat finds further support in intangible assets such as the vast collection of user behaviour data and intellectual property ownership that hold significant commercial value. “Tencent has accumulated a huge amount of user behaviour data through each WeChat and QQ login on Tencent’s various internet services, as well as payment data through Tenpay,” says Tam, who pegs the stocks fair value at US$64, and projects a strong annual top-line growth of 19 per cent over a decade.

Moreover, the company’s fintech business has been steadily gaining muscle and represents substantial monetisation potential. “It had the second-largest mobile payment market share of 38 per cent in the fourth-quarter 2017, versus Alipay’s 54 per cent,” says Tam.

is a Toronto-based financial writer and contributor to Morningstar Canada.

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