It has been a tough year for Chinese tech stocks that had once reached high levels. Chinese internet giant Tencent (OTCMKTS:TCEHY) has had an especially tough 2018. Tencent stock peaked in January 2018 at over $60, a mark that capped a near sixty-fold increase in its share price over the previous decade. But the decade-long uptrend in TCEHY stock price ended this year.
Since peaking in January, TCEHY stock has dropped nearly 40%. That is a big drop. It is also the stock’s biggest correction ever, implying that this selloff could be the end of Tencent’s bull run.
Is that fact or fiction?
It’s a bit of both. The factual part is that TCEHY stock price still isn’t that cheap if persistent margin headwinds hang around and/or the Chinese economy continues to slow at a meaningful pace. But Tencent stock still has exposure to some of the biggest growth tailwinds in the world, and those growth tailwinds won’t be ignored by the market forever.
Thus, the game plan for TCEHY stock is simple. The recent weakness of Tencent stock will become an opportunity if its margins firm up and its revenue growth stabilizes. Until those things happen, it’s probably best to avoid Tencent stock.
The Long-Term Growth Outlook Is Promising
The long-term bull thesis on TCEHY stock is quite compelling.
This is a company with robust exposure to all things internet in China. Tencent is perhaps most noted for being the Facebook (NASDAQ:FB) of China. This comparison has some merit. 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. Thus, Tencent’s social media ecosystem is very similar to Facebook’s social media ecosystem. Yet Facebook stock has a market cap of $430 billion, while Tencent stock has a market cap of $360 billion. The discrepancy implies that TCEHY stock price has room to run higher.
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, but 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 multi-year growth outlook. As a result, in the big picture, the near-term weakness of TCEHY stock price is a long-term buying opportunity.
Near-Term Headwinds Accentuate Risk
But stocks are all about timing, and right now may not be the best time to buy the dip in TCEHY stock.
Margins have been a big issue for this company for the past several years. In early 2015, TCEHY had 60%-plus gross margins and 40%-plus operating margins. But big investments and a shift to lower-margin revenue streams have dragged its margins way lower ever since. Today Tencent has 47% gross margins and 30% operating margins, and both of those metrics are rapidly dropping.
Margin compression wasn’t a huge problem for TCEHY from 2015 to 2017 because its revenue growth was big enough to offset its margin compression. But last quarter its 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.
Thus, until Tencent’s profits start growing at a healthy rate again, Tencent stock is unnecessarily risky.
The Bottom Line on TCEHY Stock
The long-term bull thesis on Tencent stock is compelling. But it’s not a good idea to buy TCEHY stock here and now. As long as concerns about the company’s margins persist, it will be tough for TCEHY stock to bounce back.
As of this writing, Luke Lango was long FB.