In 2023, Chinese stocks have massively underperformed in developed markets contrary to expectations. Investors anticipated a lift from economic growth after the end of the COVID-19 lockdown measures, but this has yet to materialize. Instead, the Chinese economy has been weak and government efforts to stimulate the economy are failing.
While China’s economic weakness has dominated the headlines, there are reasons to be optimistic about undervalued Chinese stocks. First, although economic data has been disappointing, the Chinese economy is expected to grow at 5% in 2023. That’s a faster rate than developed economies in Europe and the U.S.
Furthermore, the excessive negative sentiment has made Chinese stocks undervalued compared to U.S. stocks. For instance, the iShares China Large-Cap ETF (NYSEARCA:FXI) trades at a trailing price-to-earnings ratio of 11. In contrast, the SPDR S&P 500 ETF Trust (NYSEARCA:SPY) has a trailing P/E of 22.
Another reason to be optimistic is the stimulus efforts from the Chinese government. The state has unveiled measures such as cutting rates, loosening mortgage lending standards, and reducing banking foreign reserve requirements. These stimulus efforts could be the catalysts needed to trigger a rally in these undervalued Chinese stocks.
Alibaba (BABA)
This e-commerce giant is one of the best Chinese stock opportunities. Despite announcing value-creating spinoffs earlier in the year, the stock has underperformed. However, given the solid fundamentals, this underperformance might be short-lived.
First, Alibaba (NYSE:BABA) is the largest e-commerce platform in China, with almost 50% market share. It operates ecosystems such as Taobao and Tmall in China with millions of users. Additionally, it has expanded internationally. It owns South East Asia e-commerce retailer Lazada and Trendyol in Turkey.
Secondly, after four quarters of abysmal revenue growth below 3%, the company’s growth accelerated in the first quarter of fiscal year 2024. It reported a 14% year-on-year increase in revenue. And due to improvements in operations, adjusted EBITA increased 32% YOY.
The company is seeing improved customer acquisition and retention trends on the Taobao app. At the same time, its international platforms, including AliExpress and Lazada, reported an impressive 25% YOY growth rate.
Looking at the cloud business, it reported 4% YOY growth. Management is optimistic about the opportunities for this division going forward. Since customers are increasingly adopting cloud computing and generative AI, Alibaba Cloud will benefit.
Lastly, the most significant catalyst for BABA stock is the plan to split into six separate units. It expects to separate into Taobao Tmall Commerce Group, Cloud Intelligence Group, Local Services Group, Global Digital Commerce Group, Cainiao Smart Logistics, and a Digital Media and Entertainment Group. This strategic transformation will unlock value and create more nimble operating units.
E-commerce is a secular theme, and Alibaba will dominate the China and South East Asia markets. Buy the stock at a bargain and wait for the split to create value.
JD.com (JD)
JD.com (NASDAQ:JD) is another undervalued Chinese stock in the retail segment. A glance at the valuation reveals a bargain forward P/E of 17. Yet this e-commerce giant is reporting solid results and is set for long-term growth from the secular e-commerce shift.
The stock has underperformed Chinese peers like Alibaba and PDD Holdings (NASDAQ:PDD) year-to-date. As of this writing, it is down 42%, while PDD is up 16%. However, the decline is overdone and the fundamental outlook for the business is improving.
After an unsuccessful foray into international markets, the company closed its e-commerce services in Southeast Asia to focus on domestic operations. The company is known in China for its high-quality products and best-in-class service. It is well-positioned to serve the growing Chinese middle class through its business-to-consumer model and vertically integrated operation.
The latest quarterly results highlighted the growing momentum. In the quarter, marketplace merchants more than doubled to a record high. This milestone aligns with its goal to provide a wide selection of high-quality merchandise at value prices.
Considering the macroeconomic challenges, the 7.6% revenue growth in the second quarter was impressive. Additionally, the company gained share in some categories. “In JD Retail, we continued to gain market share in core categories of home appliances and 3C, propelled by our supply chain advantages and service quality,” said Ian Su Shan, the CEO.
In the long run, JD.com’s focus on vertical integration will bear fruit, improving delivery speed and product quality. With an increasingly affluent Chinese population, the retailer is poised for growth. Analysts agree and are bullish, with the average price target representing over 70% upside.
Tencent Music Entertainment (TME)
Music streaming has become a prevalent entertainment option for younger consumers. Tencent Music Entertainment (NYSE:TME) is a play on the Chinese music streaming market. The company provides music discovery and streaming platforms in China through QQ Music, Kugou Music, and Kuwo Music.
According to Statista, it’s the third-largest music streaming service in the world. As of June 30, it had over 99.4 million paying users. As consumers get accustomed to paying for music or premium features, paying subscribers will only grow.
The company recently delivered superb second-quarter results aided by a surge in subscriptions, with revenues increasing 5.5% YOY. The shining star was the online music services segment, which reported an impressive 47.6% YOY increase. Advertising and subscription growth were the main drivers of the growth.
Particularly impressive was the 20% increase in the number of music subscribers. Management highlighted the rising trend in paying users. “As we continue driving the healthy development of China’s online music industry, we have seen users become increasingly accustomed and willing to pay for copyrighted music,” said Mr. Cussion Pang, Executive Chairman of TME.
The company is deepening relationships with iconic artists and labels and refining the recommendation engine and listening features. Consequently, it can offer a personalized and immersive music experience, increasing the value of its online music service.
As of this writing, the stock trades at a bargain forward P/E of 13. With improving operating efficiencies and increasing profits, it is one of the top Chinese stocks to buy.
On the date of publication, Charles Munyi did not hold (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
