Tencent’s Apps Are Hot But the Shares Seem Fully Valued Ahead of Earnings

Tencent Holdings Limited (OTCMKTS:TCEHY) is a powerful Chinese gaming and payments company with a massive $754 billion market capitalization on its U.S.-traded ADRs. Nevertheless, TCEHY stock is probably close to full value and might not have a significant upside at least for the next year.

Tencent (TCEHY) sign on Tencent headquarters in Shenzhen, China.
Source: StreetVJ / Shutterstock.com

For example, in the past year, TCEHY stock had risen more than 87% as of Nov. 6, when it closed at $79.76. Moreover, year-to-date the stock was up over 66%, including about 52% in the last six months. In fact, in the last month alone, TECHY is up almost 16%.

But that may be the most it moves for a while, given the stock’s valuation and its recent moves. However, the company has some deep value assets that could continue to pull it higher.

Tencent’s Powerful Growth

Tencent has a fast-growing gaming division, which accounts for most of its revenue, as well as a popular payments division that includes WeChat Pay. It accounts for about a quarter or so of its revenue and is also a significant player in the Chinese economy.

For example, a research study last year said that both WeChat Pay and Alipay now account for 90% of the $17 trillion Chinese mobile payment markets.

Moreover, its gaming grew by 35% year-over-year in Q2, and Fintech payments revenue was up 30%. Tencent expects to release its earnings for Q3 on Nov. 12 Shenzhen, China time (which is actually Wednesday night in the U.S.).

However, since the company does not list its ADRs in the U.S. market (they appear to be unsponsored ADRs), it does not have to file quarterly SEC 10-Qs. As a result, it does not have to break out its revenue sources more carefully.

Nevertheless, Tencent does produce adequate financial statements on its website. Tencent shows its cumulative cash flows, which is rare for Chinese companies, and indeed for international equities in general. The statement for Q2 shows it produced free cash flow of 81.1 billion RMB (about $12.27 billion).

Tencent Stock Looks Expensive

On an annualized basis, the run rate is about $25 billion. As a result, the FCF yield for TCEHY stock is very expensive at 3.31% (i.e., $25 billion divided by $754 billion market cap).

However, it is similar to the high valuation on Alibaba (NYSE:BABA), which also has a similar FCF yield. I pointed this out in my Oct. 6 article on BABA stock.

A number of analysts agree with my assessment that Tencent stock is close to full value. For example, both Marketbeat and TipRanks report that the average Wall Street brokerage target price is $81.00 per share.

That represents a mere 1.55% potential gain for the TCEHY stock. But Refinitiv data on Yahoo! Finance shows that three analysts have an average target of $71.90, or a possible downside of 10% from the Nov. 6 price of $79.76.

In other words, analysts are not that sanguine about the upside left in TCEHY stock. However, that is not necessarily worth anything, especially since Wall Street often gets price targets wrong. But here is something else to consider.

Right now earnings estimates for 2020 are for $1.76 this year and $2.35 next year. That puts TCEGY on a 2020 price-to-earnings (P/E) ratio of 45 times this year and 34 times next year. Those are fairly high P/E multiples, indicating the stock is close to full value right now.

What’s Next For TCEHY Stock

Recently the U.S. government has been trying to prevent American users from downloading WeChat, the popular Tencent mobile app. So far, an appeals court has prevented this from happening, at least until the case is heard in January.

After that, it may anybody’s guess what happens, and I won’t try to postulate one. But what seems clear is that this is currently not an important app in the U.S., at least compared to TikTok, for example.

I also do not think this will affect the valuation of the stock. The company’s upcoming earnings report on Nov. 12 has the potential to move TCEHY stock much more. For example, analysts currently expect EPS to come in at 46 cents per share, which would be similar to last quarter.

However, if EPS is significantly higher than that estimate, then earnings estimates for this year and next would have to be upgraded. That would have the potential to push TCEHY stock higher. This would especially be the case if FCF comes in at a high level like it did last quarter.

Therefore, all eyes are on its upcoming report, although for the time being TCEHY stock appears fully valued.

On the date of publication, Mark R. Hake did not have (either directly or indirectly) any positions in any of the securities mentioned in this article.

Mark Hake runs the Total Yield Value Guide which you can review here.

Article printed from InvestorPlace Media, https://investorplace.com/2020/11/tcehy-stock-looks-fully-valued-despite-high-growth-rates-in-gaming-and-payments/.

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