The Bear Continues To Dominate
The Hang Sang Tech index has tumbled 23% ytd, just a mere 390 points or 9% to the low when the pandemic started in Mar 20. What makes the overall investment landscape different from 2020’s is the sluggish retail data, a more stringent regulatory environment and heightened geopolitical risks. We maintain our MARKET WEIGHT view on the internet sector. We prefer JD.com and TCEL in such a challenging investment landscape.
WHAT’S NEW
• Near-term headwinds persist. The geopolitical tension which began on 24 Feb 22 has caused the HSTech Index to tumble by 17% (as at 8 Mar 22). While we reckon this may present attractive buying opportunities, other structural changes such as a stringent regulatory environment and sluggish retail sales data may continue to weigh on investors’ sentiment.
a) Retail sales. As guided during the recent earnings call with Alibaba, we understand that the company’s gross merchandise value (GMV) growth during 3QFY22 had continued to grow at single digits (2QFY22 was single digits as well), although the company did not share its January/February online retail sales performance (while we are awaiting data from the National Bureau Statistic (NBS), we feel that the online
retail sales performance will continue to be disappointing in 2022 given the recently guided slower GDP target of 5.5.% and expected monetary easing to spur spending and investment activities.
b) Regulatory landscape. The increased regulatory scrutiny to bolster the cybersecurity regulations was no stranger in the China market but also commonly seen in the global front especially with some of the infamous cases such as Facebook and Google being fined by France (source), the privacy violation by Facebook against the EU (source) etc. This had resulted in most of the local tech companies reporting slower online advertising revenue growth in the recent financial quarter. Reading across companies that had reported their Dec 21 results ie Baba, Weibo, Baidu and Bili, the large cap names especially Alibaba customer management revenue’s (CMR) segment revenue for Dec 21 quarter had slowed to -1% vs Dec 20’s +40% growth, whereas Bilibili also saw slowing growth of +119.8% vs +149.5% in 4Q20; the other two names — Weibo and Baidu had shown marginal improvement growth of +21.5/+0.1% vs 4Q20’s
+11.7/-0.3%. Other than the potential slower online advertising growth, we could also see a slowdown in the online game segment driven by the seven-month long new game approval halt. There could be some improvement in investor sentiment if the new game approval resumes. However, this will not necessarily translate into meaningful revenue growth in the short term as a game needs at least 12 months after obtaining approval (for demo assessment, public testing, promotion and marketing) before it can be launched.
• Quality growth and strong fundamentals will be crucial. In the near term, we favour companies which should continue to deliver double-digit revenue growth as well as able to sustain robust earnings growth. Recall that Bili recently reported strong growth in their 4Q21 revenue (+51%); however, the widening net loss had resulted in heavy selldown. In view of that, JD.com and Tongcheng e-Long are our top picks in the internet sector.
a) JD.com is our top pick from the e-commerce sector due to its robust omnichannel strategy, relatively less exposure to regulatory risks as well as potential further margin improvement driven by its expansion in the 3P segment. At this juncture, we believe JD.com deserves a valuation premium over Baba as the company was still able to record a 23% yoy growth in 3Q21 under its online direct sales segment vs Baba’s CMR revenue growth of 3%.
b) Tongcheng e-Long. We expect a bumpy recovery path for 2022; after seeing the recent COVID-19 regional outbreaks and lockdowns during 1Q22, we expect China’s Zero Case Policy to persist into 2H22. Given the absence of border reopening catalysts, we prefer Tongcheng e-Long in the online travel agency (OTA) sector as: a) it is a proxy to the domestic tourism’s recovery amid the absence of overseas tourists,
c) OTA names are less susceptible to the regulatory risks, and c) its relatively assetlight business nature enables the company to deliver a robust and better-than-peers margin performance (TCEL’s net margin was 16% in 2020 vs Trip.com’s -5%). ESSENTIALS
• In our peer comparison table below (sorted by 2022 revenue growth), China’s internet sector revenue and net profit growth on average is still expected to outpace US peers (according to street’s estimate) in 2022. In terms of valuation, China’s tech sector appears to be relatively undervalued as compared with US peers with 2023E forward PE of 21x vs 27x from the US peers. As such, we believe the downside risk for China’s internet sector should be limited as compared with US peers (not to mention the further downside risk when the Fed raises interest rates in 2022).
SECTOR CATALYST AND RISK
• Catalysts: a) Supportive government policies, b) increasing online retail penetration driven by less developed areas and younger generations, and c) continued improvements in technology and e-commerce infrastructure.
• Risks: a) Uncertain geopolitical risks, b) a challenging regulatory landscape, c) weak macro environment, d) high user acquisition expenses as well as increased competition as multiple players seek to increase market shares and heavy investments in new retail, and e) local services strategy dragging down e-commerce companies’ margins and ROEs.