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Tencent Earnings Underscore the Current Problem With Chinese Tech Stocks

Tencent stock, like other China tech stocks, has become a near-term pain, long-term gain situation

By Luke Lango, InvestorPlace Contributor

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Often dubbed the Facebook (NASDAQ:FB) of China, Tencent (OTCMKTS:TCEHY) just reported quarterly earnings that were eerily reminiscent of Facebook’s ugly second-quarter report.

As was the case at Facebook, Tencent reported slowing revenue growth alongside margin compression, the combination of which led to Tencent’s first profit drop in ten years. Moreover, the company’s 30% top-line growth rate was the slowest revenue growth the company has reported in three years.

Overall, the quarter wasn’t good, and TCEHY stock dropped big in response. This is nothing new for China tech stocks, all of which have been in free fall mode ever since trade war tensions heated up and economic growth in China has cooled.

TCEHY stock is down 20% in 2018. Big peers Alibaba (NYSE:BABA), Baidu (NASDAQ:BIDU) and JD (NASDAQ:JD) are all more than 20% off their 2018 highs. Small peers Weibo (NASDAQ:WB), Momo (NASDAQ:MOMO), iQIYI (NASDAQ:IQ) and Huya (NASDAQ:HUYA) are all more than 30% off their 2018 highs.

In other words, all China tech stocks are in free fall right now, TCEHY stock included. This freefall isn’t showing any signs of easing up any time soon as global trade tensions are only rising and China economic data continues to weaken.

On the flip side, many of these China tech stocks are now dramatically undervalued, and have huge upside in a long term window. Thus, the investment game-plan here is simple. Stay away for now. Wait for the dust to settle. Wait for global trade tensions to cool down, and for China’s economy to get back on sure footing. Then, buy the dip in these way undervalued China tech stocks, TCEHY stock included.

Tencent’s Earnings Weren’t Very Good

Tencent’s Q2 report was actually quite bad.

Revenue growth across the board slowed by a whole bunch. Total revenue growth slowed from 48% in Q1 to 30% in Q2, the slowest growth rate in three years. Online games revenue rose just 6%, versus a 26% jump in the prior quarter. Social networks revenue jumped 30% higher, much lower than Q1’s near 50% growth. The advertising business saw revenue growth decelerate from 55% to 39% sequentially.

Meanwhile, margins got slashed because of lower margin businesses driving revenue growth. Also, the company is investing big in order to maintain strong top-line growth, so the operating expense rate is crawling up. All together, operating margins fell back 10 full points in the quarter.

Slowing revenue growth on top of huge margin compression led to Tencent reporting its first profit drop in a decade.

Overall, Tencent’s quarter was rather bad, and speaks to recent economic weakness in China persisting for the foreseeable future. That doesn’t bode well for TCEHY stock over the next few months.

China Tech Stocks Are Getting Slammed

TCEHY stock isn’t alone in this sell-off. Across the board, all hyper-growth China tech stocks are dropping like rocks.

Why? Quite simply, the U.S. is winning its trade war with China, and that is causing the formerly red-hot China economy to cool off. This cooling off is showing up in China tech stock numbers, which have for the most part been good, but not great or up to historical standards. The net result is a big sell-off in the China tech sector.

This weakness will likely persist. There aren’t any signs that trade war tensions will ease any time soon. Plus, the whole Turkey debt crisis has added an additional global economic risk factor which wasn’t there before. As such, the current state in China isn’t improving. Until the China economic growth narrative inflects upward, China tech stocks will remain weak.

Long-Term Value Will Emerge After Near-Term Pain

Eventually, China’s economic growth narrative will inflect upward. After all, this is an economy still expanding at a near 7% rate with a ton of consumers who are tapping into only a small portion of their potential economic power.

When the growth narrative surrounding China does improve, these China tech stocks will bounce back in dramatic fashion. Many of them, TCEHY stock included, have dropped into hugely undervalued territory, trading at sub-20 earnings multiples for 30%, 40%, and even 50%-plus earnings growth.

As such, a golden buying opportunity for long-term investors is forming as a result of recent weakness in China tech stocks. But, the time to buy is not now. Let TCEHY stock and other China tech stocks fall further as the narrative in China remains dour. Once signs point to that narrative improving, that will be the time to buy for the long haul.

Bottom Line on TCEHY Stock

Like other China tech stocks, TCEHY stock will continue to drop in the near term due to deteriorating sentiment and fundamentals in China.

In the long-run, though, this stock will eventually find a bottom, and could stage a huge rally from there over the next three to five years.

As of this writing, Luke Lango was long FB, BABA, and JD.


Article printed from InvestorPlace Media, https://investorplace.com/2018/08/tencent-earnings-underscore-the-current-problem-with-chinese-tech-stocks/.

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