It appeared that Chinese tech titan Tencent Holdings (NASDAQOTH: TCEHY) was well on its way to getting its mojo back. Then the first-quarter 2019 report and a deterioration in trade negotiations between the U.S. and China happened.
To be fair, Tencent's video gaming business is stalled out for now, and growth in its social media and related entertainment and subscription offerings is decelerating. But for a company that's valued on U.S. markets at $415 billion, who's going to complain about headline growth of 16%? Apparently, quite a few people, as the stock has dropped. However, this looks like a buy-the-dip situation to me.
What happened in Q1
The stunning rally that started with the new year took a step back, and Tencent shares are now up only 10% year to date as of this writing (they were up over 25% before the first-quarter report). That return is nothing to balk at, except that the stock took a 43% beatdown during the 2018 calendar year as revenue and profit growth started to slow.
It would appear the slowdown isn't finished yet, as the first quarter of 2019 comprised Tencent's slowest revenue growth since it became a public company. Investors are also worried that the recent escalation in the trade dispute between Washington, D.C., and Beijing will damage China's economy and, in turn, one of its big-three technology leaders.
|Metric||Q1 2019||Year-Over-Year Increase (Decrease)|
|Operating profit margin||43%||1.3 p.p.|
|Profit (loss) from associates and joint ventures||($444 million)||N/A|
|Earnings per share||$0.43||16%|
P.p. = percentage point. Profit from joint ventures and earnings per share calculated using the Chinese renminbi to U.S. dollar exchange rate from March 31: 1 renminbi = 0.15 dollars. Data source: Tencent Holdings.
At Tencent, the video game segment -- which made up a third of total revenue in the quarter -- is still recovering from the temporary freeze placed on new game releases by Chinese regulators last year. Sales in the segment fell 1% year over year, but did increase 50% from the fourth quarter. Digital advertising increased 25% year over year on Tencent's social networks, but that was a slowdown from the 44% rate notched in full-year 2018.
The real eyebrow-raiser was in fintech and business services, which the company is reporting as a stand-alone segment for the first time. Led by financial services and cloud computing, the segment represented 25% of Tencent's total revenue in the quarter and grew a whopping 44% year over year. Granted, Tencent used to report these businesses under the "other" catchall segment, which grew 80% in 2018. So, though this, too, is a cooldown from the recent past, the 44% rate is nonetheless a good one.
Image source: Getty Images.
Buy the dip?
Investors have fretted over anything having to do with China for over a year now, and that may not change anytime soon. Nevertheless, Tencent is still a solid company with plenty of growth prospects. The business has developed into a diversified technology platform, and a couple of segments -- notably video games and other "value added services" -- are bogging down an otherwise fast-expanding social media and fintech enterprise. Earnings aren't moving as fast as some shareholders would like, but that is in large part because Tencent is still investing into itself and into its partners to expand its ecosystem of services.
Thus, even though Tencent is a huge operation these days, this is still very much a growth-now profit-later stock. That shows up in the rich trailing price-to-earnings ratio of 34.7. But it's not excessively overpriced, especially if the video game business continues to recover and begins to contribute to overall expansion again, which management fully expects it to do. There were a number of new game releases last quarter and a few more slated for the current quarter. Shares are likely to continue to be volatile, but Tencent still looks like a good pick to me.
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