The recent U.S. stock market rout started in early October. But many months before U.S. stocks started falling off a cliff, China stocks were dropping into correction territory.
The rationale behind the selloff in China stocks is pretty straightforward. The China economy has been flashing warning signs of cooling off for several months, while the U.S. dollar has concurrently strengthened. Amid this economic slowdown and U.S. dollar uptick, U.S. and China trade tensions have not improved, and the probability of bigger and more wide-sweeping tariffs coming in 2019 is now quite high. Bigger tariffs could accentuate China’s economic slowdown, and this will inevitably result in slower growth numbers across all of China’s big companies.
This is the mindset investors have taken with China stocks over the past several months. It’s quite bearish. But, it isn’t wrong, either. China’s economy is slowing, and tariffs could slow things down even more. As such, the near term outlook for China stocks is fairly bearish.
But while the near-term outlook is bearish, the long-term outlook is bullish.
In the big picture, this is still a country with over a billion people, most of whom are rapidly urbanizing and digitizing. GDP growth is still in excess of 6%, while household income and expenditures per capita still remain a fraction of what they are in the U.S. Long term, the consumer landscape of China will increasingly look like the consumer landscape in America, implying that big growth is here to stay for the next several years. As this urbanization narrative matures over the next several years, China stocks should bounce back.
With that in mind, here’s a list of eight China stocks with exposure to all of China’s most promising growth themes, making these stocks the most likely to rally in a big way once near term risks pass.
At the top of this list is China’s most well-known and biggest tech company, Alibaba (NYSE:BABA).
For all intents and purposes, Alibaba is the Amazon (NASDAQ:AMZN) of China. They have a huge and rapidly growing e-commerce business. They also have a huge and rapidly growing cloud business. There is also a big-growth digital advertising business, a rapidly expanding offline retail business and a still-developing AI businesses. All together, both companies have consistently exhibited 20%-plus revenue growth.
There’s just three big differences between the fundamentals of Amazon and the fundamentals of Alibaba. One, Alibaba is far more profitable. Alibaba’s operating margins are around 20%. Amazon’s are near 5%. Two, Alibaba is growing way faster. Alibaba’s revenue growth was in excess of 50% last quarter. Amazon’s was below 30%. Three, Alibaba stock is way cheaper. Alibaba stock trades at under 30X forward earnings. Amazon stock trades at 80X forward earnings.
The big reason Alibaba stock is way cheaper has two parts. First, Alibaba is cheaper because of near-term headline risks inherent to the Chinese economy — but eventually, these headline risks will pass. Second, Alibaba is cheaper because margins are compressing, not expanding. Margin compression is a temporary phenomena sparked by big growth-related investments that will pass with time.
As such, the headwinds keeping Alibaba stock are short-sighted in nature, while the tailwinds are long-running. This makes Alibaba stock a likely candidate for a big bounce once U.S. and China trade relations improve.
Second on this list is Alibaba’s competitor and China’s second biggest e-retailer, JD (NASDAQ:JD).
Much like Alibaba, JD is a hyper-growth tech giant powered by a rapidly growing e-commerce business. Also much like Alibaba, the big problem with JD is slowing revenue growth and margin compression against the backdrop of a Chinese economy that is rapidly cooling. Last quarter’s 25% revenue growth rate pales in comparison to the year ago quarter’s 40% growth rate, while operating margins are down 90 basis points year-to-date to a measly 0.5%.
Until revenue growth or margin expansion trends turn around, JD stock won’t rebound.
Fortunately, they should be able to turn around. Slower growth recently is a reflection of economic uncertainty in China due to strained trade relations. Eventually, those trade relations will improve, and when they do, JD’s revenue growth should bounce back. Plus, growth should get a big lift as the company expands internationally into new markets.
Moreover, much like at Alibaba, margin compression at JD is a temporary phenomena driven by growth-related investments that will inevitably phase out over time.
Thus, in the big picture, JD is just fine. The bull thesis is predicated on valuation. At current levels, JD stock is trading at less than 0.5X trailing sales. That multiple strongly implies continued revenue growth deceleration and continued margin compression. From this perspective, the current valuation on JD gives this China stock ample room to run higher when revenue growth and margin trends reverse course.
Much like the other stocks on this list, WB stock has dropped due to a combination of slowing growth, trade risks, and margin headwinds. But, also much like other stocks on this list, these headwinds are temporary, while the company’s tailwinds are robust and long running.
The long term fundamentals underlying Weibo stock are quite promising. You have a red hot social media company that has 430 million monthly active users and is consistently adding about 20 million new users every quarter. You have revenue growth that was in excess of 60% last quarter. Also, margins are stable year-over-year.
This growth isn’t going anywhere any time soon. Weibo has generated just $1.5 billion in trailing twelve month revenues on 430 million users. Its U.S. comp, Twitter, has generated nearly twice as much on 100 million fewer users. When all is said and done and the China and U.S. digital ad landscapes are both mature, there is no reason why Wiebo’s users should generate less revenue than Twitter’s users. Thus, Weibo has a tremendous runway ahead to scale ARPU to Twitter levels.
This robust unit growth potential on top of consistent user growth will power continued 20%-plus revenue growth for many years to come. Meanwhile, margins should at worst remain stable, and more realistically grow with robust revenue growth. That implies something to the tune of 20% to 30% earnings growth over the next several years.
WB stock trades at just 18X forward earnings. Coca Cola (NYSE:KO) trades at a slightly higher multiple. That makes no sense.
Another China stock with hulking long-term upside is live streaming and social media company Momo (NASDAQ:MOMO).
Momo is a really good company doing innovative things in a really good space. Momo’s business most closely resembles Tinder, as the platform is designed to be a couples and friends match-making service. This is a good space to be in. It runs parallel to the whole social media growth narrative playing out in China, but also evades competition because it is niche and designed for a purpose unmet by other Chinese social platforms.
But, Momo is much more than just China’s Tinder. The company is a leader in China’s booming live-streaming market. To be sure, growth in this market is decelerating and the Chinese government is starting to step in and crack down. But mobile phone penetration and usage is only going up from here, and with it goes mobile video consumption and live-streaming. As Elijah Whaley, CMO of ParkLu, which manages Chinese live-streaming stars, observed: “Mass programming cannot satisfy niche interests.”
Overall, the growth narrative at Momo is not broken. Recent numbers affirm this. Q2 was a clean double-beat-and-raise quarter for Momo that comprised nearly 60% revenue growth and 90% profit growth.
Like many China stocks, the bull thesis on MOMO stock is predicated on valuation. Despite continued strong numbers, Momo has sold off in sympathy with other China stocks. Consequently, MOMO stock now trades at just 13X forward earnings. That multiple makes no sense next to 90% profit growth last quarter, nor next to the company’s strong growth fundamentals in China’s still rapidly growing digital economy. As such, once near-term headline risks pass, MOMO stock could bounce back in a big way.
A list of China stocks with long-term upside would be incomplete without including China’s go-to online travel site, Ctrip (NASDAQ:CTRP).
Often referred to as the Expedia (NASDAQ:EXPE) of China, Ctrip was a big winner for the better part of the past decade thanks to a boom in China air travel. As China consumers have urbanized and earned more, they have naturally wanted to travel more and spend those new dollars seeing the world. As such, the narrative at Ctrip has been one characterized by robust and consistent top and bottom line growth.
This narrative is slowing now. Last quarter, revenue growth was just 20%. In the year ago quarter, it was over 40%. Moreover, revenue growth next quarter is expected to be below 20%. This slowdown can be attributed to ongoing macroeconomic uncertainty in China, and will persist so long as such uncertainty remains.
But, that uncertainty won’t remain forever, and the long-term fundamentals here are really good. Just 7% of Chinese citizens have a passport. That is really low. In America, that figure stands closer to 40%. Moreover, Chinese tourists made just 145 million overseas visits last year, which equates to just 10% of the total population. Because of this, the China Outbound Tourism Research Institute (COTRI) predicts that overseas trips will grow from 145 million last year, to over 400 million by 2030.
Naturally, as this growth narrative plays out, CTRP stock will be a big winner. As such, once near-term headline risks pass, CTRP stock should grow alongside a still burgeoning China air travel growth narrative.
Chinese digital search giant Baidu (NASDAQ:BIDU) has not been spared in the recent China stock market rout. The stock peaked in May 2018 at over $280. Since then, BIDU has dropped more than 35% to $180.
Much like the other stocks on this list, Baidu has been hampered by a combination of headwinds. Revenue growth is slowing. Margins are under pressure. Forward growth estimates are coming down. Analysts are growing increasingly pessimistic.
But, beyond the noise, the long term fundamentals supporting Baidu stock are still pretty strong. Baidu is China’s Google (NASDAQ:GOOG, NASDAQ:GOOGL), and as China’s Google, Baidu provides the backbone for China’s internet. Beyond that, Baidu has high-growth cloud, IoT, and AI businesses, the sum of which are still in the early stages of a multiyear growth narrative.
All together, so long as internet usage continues to rise in China and enterprise investment into things like cloud and AI continues to grow, Baidu’s growth fundamentals should remain strong. That is a promising read. But, the big concern here is margin compression (operating margins were down 500 basis points last quarter). Until those margins reverse course, BIDU stock won’t bounce back.
Margins should bounce back in the medium to long term. Over the next several years, digital advertising, AI, IoT and cloud growth will likely power 15%-20% revenue growth at Baidu. During that stretch, it will be tough for expenses to keep up with revenue. Right now, Baidu is being weighed by huge losses at iQiyi (NASDAQ:IQ) and big investments into the app ecosystem. Eventually, iQiyi’s margins will improve with scale, and big investments into apps will scale back once the app ecosystem is fully fleshed out. When that happens, these big expenses dragging margins down will phase out, and margins will ramp higher on a much bigger revenue base.
Thus, BIDU stock has big bounce back potential at current levels. The stock won’t realize that potential until margins stabilize and/or the trade situation improves. But, these aren’t a matter of “if.” They are a matter of “when.”
Chinese internet giant Tencent (OTCMKTS:TCEHY) has had an especially tough 2018. Tencent stock peaked in January 2018 at over $60, and now trades below $40.
The big problem here is revenue deceleration. Margins are compressing, but they’ve been compressing for the past several years. In early 2015, TCEHY had 60%-plus gross margins and 40%-plus operating margins. Big investments and a shift to lower-margin revenue streams have dragged margins way down since then. Today, Tencent has 47% gross margins and 30% operating margins, and both of those metrics are rapidly dropping.
But, margin compression wasn’t a big problem for Tencent from 2015 to 2017 because revenue growth was big enough to offset margin compression. That is no longer the case. Last quarter, revenue growth decelerated meaningfully. That deceleration negatively impacted the company’s bottom line, as its operating profits actually dropped year-over-year.
Therefore, unless Tencent’s revenue growth re-accelerates or its margin declines moderate, the outlook for Tencent’s profit growth isn’t all the great. At this point, with the Chinese economy slowing, no positive progress on U.S.-China trade talks, and Tencent’s top- and bottom-line issues, there is little reason to believe TCEHY stock will reach a positive turning point anytime soon.
Long term, though, the upside is compelling. This is a company with robust exposure to all things internet in China. Tencent operates China’s largest social media platforms — Weixin and WeChat — and they have more than 1 billion combined active users. The company’s other social media and communication apps — QQ and Qzone — aren’t small either. They both have 500 million-plus monthly active users. Beyond social, Tencent is also the gaming giant in China, and it’s the top online games maker by revenue in the world. TCEHY also owns China’s biggest digital video, news, music, and literature platforms. As if that weren’t enough, Tencent also operates China’s largest mobile payment platform and its largest mobile security network.
In other words, TCEHY not only has exposure to all things internet in China, it actually dominates all things internet in China. Thus, as goes the outlook for the growth of internet services in China, so goes Tencent. Considering that demand for internet services is expected to continue growing rapidly in China, Tencent stock is still supported by a favorable multiyear growth outlook.
As a result, in the big picture, the near-term weakness of TCEHY stock price is a long-term buying opportunity. But, investors will want to wait for revenue growth turn the corner and/or margin declines to moderate before buying the dip.
The riskiest yet potentially most rewarding stock on this list is Huya (NASDAQ:HUYA).
Huya is China’s leading video streaming platform, and that inherently implies huge speculative long-term growth potential for this stock. Across the globe, live streaming video game viewership numbers are skyrocketing, and everyone from Amazon to Google to Facebook (NASDAQ:FB) is investing big into this market.
But the biggest growth is happening China, where Huya reigns supreme. China is the world’s largest games market in terms of revenue and gamers. In 2017, gaming revenues were $32.2 billion in China, versus $26.4 billion the U.S. The disparity is mostly driven by the fact that China has 646 million gamers, essentially double the entire U.S. population.
And this disparity is expected to only widen. Over the next five years, an expansion in China’s gamer base from 646 million to 917 million is expected to drive 13% compounded annual growth in gaming revenues. Meanwhile, in the U.S., gaming revenues are expected to grow at a mere 5% clip over the next five years.
Clearly, China is the big growth story here. And when it comes to China video game live streaming, Huya is king with almost 50% market share (83 million monthly active users last year versus China gaming monthly users of 180 million).
Consequently, as the China eSports and live streaming markets explode higher over the next several years, Huya stock should climb higher, too. But, this bull thesis isn’t without risk. Recent weak quarterly numbers imply market share erosion and slowing growth. If these trends persist, Huya stock will be stuck in its current downtrend.
As such, the long-term growth narrative on Huya stock is promising. But, there are near term risks which should investors on the sidelines for the near term.
As of this writing, Luke Lango was long BABA, AMZN, WB, BIDU, GOOG, and FB.