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Global Emerging Market Equities, Propitious Research

Wium Malan, CFA

Global Emerging Market Equities

Independent, Fundamental Quantitative Research

Propitious Research

Fully independent, fundamental and quantitative equity research, focused on companies in the Telecommunication, Media, Technology, Internet and Healthcare sectors in the Global Emerging Markets. Idea generation focused on Quality stocks, trading below their intrinsic Value, with sound Corporate Governance.

Equity Bottom-Up

<a href="https://www.smartkarma.com/entities/tencent-holdings-ltd" target="_blank" data-smartkarma-citation="entities:26:1" rel="noopener">Tencent (700 HK)</a>’s investment track record has been nothing short of remarkable, as is evidenced by the increase in the reported fair value of listed Investees, which has grown by 99%y/y to nearly RMB1.45trn as of 30 June 2021, contributing as much as 31% to Tencent’s market cap. These investments have also driven material income statement gains that account for the bulk of Tencent’s positive operating profit earnings surprises over the past 2 years. However, based on share price weakness experienced post the most recent reporting period, I estimate that the current fair market value of listed associates could have declined by 26%, or RMB378bn, which is also likely to have a materially adverse impact on reported income statement numbers for 3Q21. Given that Tencent is already facing very tough comps from its online gaming revenue segment, a negative impact to “Other gains, net” could provide for significant earnings miss in 3Q21 reported numbers. If we add to that the ongoing uncertainty around the Chinese regulatory environment and economic slowdown, we could see more short-term volatility in Tencent’s share price. The main caveat to this is that, with a resurgence of the Delta-variant and COVID-19 pandemic, we could see a near-term pickup in online gaming revenue as lockdowns intensify in China, which should be positive for Tencent’s near-term earnings outlook. Tencent currently trades on a 22.1x NTM PE ratio, which is roughly 2 standard deviations below its 5-year historical average trading range. Should we exclude Tencent’s Investees at fair value, I estimate that Tencent’s consolidated operations currently trade on only a 12.1x NTM PE ratio which remains an extremely attractive longer-term entry point to the consolidated operations that are expected to grow Net Operating Profit After Tax (NOPAT) at mid-teens levels from next year onwards, even if we factor in further near-term earnings downgrades, economic headwinds to the advertising segment, or an increase in tax rates for the online games segment.

Tencent (700 HK)’s investment track record has been nothing short of remarkable, as is evidenced by the increase in the reported fair value of listed Investees, which has grown by 99%y/y to nearly RMB1.45trn as of 30 June 2021, contributing as much as 31% to Tencent’s market cap. These investments have also driven material income statement gains that account for the bulk of Tencent’s positive operating profit earnings surprises over the past 2 years. However, based on share price weakness experienced post the most recent reporting period, I estimate that the current fair market value of listed associates could have declined by 26%, or RMB378bn, which is also likely to have a materially adverse impact on reported income statement numbers for 3Q21. Given that Tencent is already facing very tough comps from its online gaming revenue segment, a negative impact to “Other gains, net” could provide for significant earnings miss in 3Q21 reported numbers. If we add to that the ongoing uncertainty around the Chinese regulatory environment and economic slowdown, we could see more short-term volatility in Tencent’s share price. The main caveat to this is that, with a resurgence of the Delta-variant and COVID-19 pandemic, we could see a near-term pickup in online gaming revenue as lockdowns intensify in China, which should be positive for Tencent’s near-term earnings outlook. Tencent currently trades on a 22.1x NTM PE ratio, which is roughly 2 standard deviations below its 5-year historical average trading range. Should we exclude Tencent’s Investees at fair value, I estimate that Tencent’s consolidated operations currently trade on only a 12.1x NTM PE ratio which remains an extremely attractive longer-term entry point to the consolidated operations that are expected to grow Net Operating Profit After Tax (NOPAT) at mid-teens levels from next year onwards, even if we factor in further near-term earnings downgrades, economic headwinds to the advertising segment, or an increase in tax rates for the online games segment.

Tencent: Investees, the Potential for ST Earnings Miss, and an Attractive LT Entry Point